(upbeat music) - Welcome to Swimming with Alligators. - The VC Podcast from the LP perspective. - With your hosts, Alexa Bins. - And Ernest, you ready? Let's dive in. - Today, our guest is John Richtegaard, Director of Capital at RBCX, the technology and innovation arm of RBC Canada's largest bank. John's team at RBCX invests in technology companies and venture capital funds, and offers a suite of credit financing solutions. As an operator turned investor, John is going to share with us today his perspective on the VC asset class as an emerging allocator, outlines some of the unique characteristics of the Canadian venture landscape and provide his view on venture's biggest challenges and opportunities ahead. Thank you, John. Let's dive in. - Awesome. Thanks for having me. - To start out, could you share your journey into the allocator position? - Absolutely. So when I was in the UK, at the time you had GDPR, consumer privacy, data cookies, regulation, tracking, everything in the top of mind, and my thesis then was like, okay, if I'm a B2B, B2C, or Director of Consumer Founder, and I previously used Facebook and Google to market to my end consumers to know that Alexa, Ernest, and John are who we are, and now because of data attribution, they only see us as customer ABC, XYZ, and 123, like that's a very scary reality, and that needs to be solved. And so the business I joined afterwards was a company called Cognitive Growth Stage technology company based at a candidate in Europe, and I was essentially Chief of Staff to the chairman. And Chief of Staff there means a lot of different things to a lot of different people, and that specific business is very much so focused on go-to-market revenue operations and corporate development. And so this is how I ended up at a bank. I was raising equity debt for this business, and honestly, I was speaking to a lot of the big Canadian institutions, and I was really mind-blown as to how backwards an approach the big banks took with respect to supporting the tech ecosystem. And I'll give you a few very clear examples. Like, I was getting pitched debt products. This is 2020-2021 that were cash flow and profitability-based loans. And at the time, as you know, tech, everything was up for felt- (laughing) - I'm like, what are those terms? (laughing) - Never heard of it. - It just made no sense. And like, if you think about a bank, and like how banks were built, banks were built off of providing traditional debt or leverage to cash flowing-based businesses. And tech companies are fundamentally different, not for cash burning, pre-profit, and scale by equity capital. So the traditional archetype of a founder or tech company was never meant to be relevant to a bank. And then I'm also working with bankers who are incredibly financially astute and financial engineers and understand, you know, the underpinnings of the business, but they weren't building tech. And so there was also been an empathy mismatch. Nevertheless, I got introduced to the gentlemen who heads up our group now at RBCX. And the whole premise that RBC saw was like, look at how much technology is contributing out of the percentage of GDP. Look at how much venture-fying Canada is getting. Look at some of the breakout companies we're getting. Look at how much employment, you know, venture-backed companies are driving the overall economy in Canada. RBC being the largest bank, it makes sense for us to build a dedicated platform and strategy that's built for the innovation economy in Canada. So now I'm in a privileged position where I get to work with, you know, a lot of amazing founders and a lot of amazing GPs and both invest from RBC's balance sheet capital as well as be partners to them in the ecosystem. - I think one thing for me, before we get into kind of like your seat now as an allocator is what's your thesis on now and where things are going from your seat? Where's the misalignment in the markets? - Yeah, it's a good question. Listen, I think, I know you said my career journey was intentional. It seems quite intentional when I play it back to you. I can tell you at the time, it, everything happened very serendipitously and I feel like that's just the way it goes. I think the misalignment that I see in the market today, you know, it's a good question. The Canadian, and I'm gonna touch on this when we speak on some of the Canadian nuances, but like I think what's interesting about Canada is when you think about the Canadian venture ecosystem, it's really only been around properly for a decade to 15 years. And so you think about that being one full cycle, there's still a lot of liquidity that's gonna be coming back and that's warranted over the course of the next five years. But what's interesting is the government's played a pretty significant role in helping prop up the ecosystem and help get it running so it's actually sustainable. And the endowments and pensions support from a Canadian perspective, you know, whereas in the US market, a lot of endowments and pension funds invest quite aggressively and supporting the venture ecosystem. In Canada, you know, we rely a little bit less on the endowment and pension capital to support from an LP perspective. And a lot of the LPs that invest in Canadian venture are actually fund the funds, family offices behind network individuals and corporations. And what was interesting when I first joined RBC and what I see now is, you know, corporations I think need to play a larger role. Like I think, you know, on the LP side specifically, even on just like the capability side, the opportunity I see is, you know, given Canada as a relatively smaller market, but there still are big businesses and big companies and technology is impacting everyone, the opportunity I point blank see is how can corporations, whether it be banks or pensions or endowments, actually double down and play a large role in supporting innovation economy? Talk to me a little bit about when you got to RBX, was the fund a fund program already there or no? And it was not, that's what I thought. So talk to me about seeing that opportunity and how you were able to even get that done and basically incubate within already a large company within like a new initiative. - 100%. - And maybe helpful even before going into that, I'll give a quick overview of the key pieces of RBX because it's actually relevant for why we ultimately do fund investing on the venture side. The business of RBCX is really, there's the way that I describe it externally, is it's essentially the group with an RBC that's responsible for advising, banking, buying, building, and investing in technology companies and funds. And so the group has 500 people across Canada and they're really segregated into four core pillars. There's a banking pillar, very similar to what SBB is in the US market, we're that in Canada in a sense that we only focus on the innovation economy. So we bank pre-sea to prep your companies, support them through deposit management, cash management, and then ultimately credit lending. So like venture debt and SaaS lines of financing. There's a platform pillar. The platform pillar is very similar to what funds would have. These are the advisors to their portfolio companies to help them scale hands-on. We have that same capability where we brought on subject matter experts on our P&L in sales, procurement, marketing, data science so that we can deploy them into our growth stage banking clients and help those clients scale a lot more hands-on so they can view the bank not as a service provider but actually as a partner to their business. We have a ventures pillar. It's all about incubation in M&A. How can we build businesses that are designed to help future-proof a traditional business like a bank as well as how can we potentially buy capability to bring in house? And then the last pillar is the pillar that I help lead is our capital pillar. So that's everything with respect to fund finance and investment management. So what my team does is we bank the majority of venture capital funds in Canada, support them through cash management and deposit management. We provide them with fund finance facilities like call line facilities and GP commitment facilities most notably. And then what I do is I invest in growth stage companies, series be up and then built out and invest in our fund and funds or fund investment vehicle which is all about investing in early stage managers. So with that context, Ernest going back to your point in terms of like how do you kind of stand this up and what opportunity did you see? Listen, I think when we first, when I first joined and when this business first got built in RBCX, RBC didn't do much with respect to venture capital fund investing. And the reason was really twofold. The first was the amount of work energy and resource that would go into making a two million to our commitment in a 20 million our fund was the same as a 200 million our fund. So naturally, they did private equity and growth 'cause funds were bigger, you can allocate more capital. And then the second reason was if you think about kind of the stereotypical institutional grade investment committee, very sophisticated individuals venture capital typically gets greeted with a ton of anxiety, right? Like, you see the return dispersion adventure. It's the widest in any private market strategy. You look at the S&P over the past 10 years, you can get a 10% compounding for the look of return. Like, that's a tough hurdle to clear. Since we've built RBCX over the course of the past three years, we've since invested in 14 firms, 16 funds. And for context, the profile of those managers have ranged from, you know, a $15 million emerging manager fund one to a $70 million fund four to a $100 million life sciences or clean tech fund. And the reason why we've been able to be more willing and keen to do these types of investments versus traditionally probably being a little bit more reserved is by viewing the asset class both financially and strategically. And what I mean by that is when I was helping build a thesis for this group, there was essentially three main insights that we saw in the marketplace that completely underpinned why we do fund investing that actually still hold true today. The first was companies are staying private longer. And so as companies stay private longer, terms are gonna be extended beyond the 10 year term. And as terms get extended, naturally, illiquidity premium is relative to the public markets that needs to go up because I am going to invest in committee not necessarily pitching a 10 year illiquid investment, but something that's more looking like 12 or 15 years. So that illiquidity was kind of like insight one. Insight two, as I mentioned, dispersion and ventures, the widest in any private market strategy, but it's actually gotten so much wider over the course of the past five years because so much liquidity has been pumped into venture and alternatives at large. Finding a top decile, let alone top quartile manager takes a ton of time, but is also like finding an ill and a haystack. So that was really interesting. And then the third insight, which is most interesting to me is if you think about the landscape of LPs, like folks who invest in venture as the asset class, whether it be an endowment or a sovereign or pension or fund a fund or family office, the only lever those folks have to generate cash inflows by way of distributions. And so they'll underwrite a manager to three extra five X net over 10 years. But for my business, it's actually a little bit different. Because what I can do is I can say, if we're looking to invest in a manager that's building a large proportion of the portfolio key and domicile companies, such that we can support them on the RBCX banking side. If they're doing so at the very early stage, like pre-seed seed, such that we're able to build relationships with the founding teams at the earliest stage of company formation. If we're one of only very few or the only Canadian financial institution in the LPs in the kit, such that we can leverage the mothership of RBC in a multitude of ways with the relationship with the partners in the portfolio companies. If the GP is probably taking more of a diversified versus pure plate concentrated approach in portfolio construction, so we're just getting exposure to a higher proportion portfolio companies as a result. And then if I'm just being mindful about, when I'm a valuing an net new manager, we're looking at the track record, we're looking at the deal flow, and we're overlaying that with the existing managers we've invested in today to ensure that the exposure is both valuable and accretive, they're so to speak, fishing in a separate pond. Fund investing becomes incredibly objective, because I can say, with a fund building a portfolio of 50 companies, of which 50% will be in Canada, and of which I think vis-a-vis a strategic partnership, we can support 80% of those Canadian companies, 50 companies, 25 Canadian, 20% at RBCX, like if I model out there with fair portfolio construction, more tally rates and graduation rates, I can say with some degree of certainty, if we put $5 million into this fund, we should be able to pay it back one times over within three years, and three times over within seven years, purely looking at revenues that we can kind of crew at the fund level, from working with the GPs, banking the fund and supporting the fund, and also banking the underlying portfolio companies. So the underlying kind of implications of the strategy, there's really two things that kind of fall out of it. The first is, instead of only having one leaguer for cash inflow, we actually have three, which help the terminal profile of our performance at the end of the fund's life to be able to accrue revenues at the fund portfolio company and distribution level. But we've also been able to somewhat solve liquidity for the bank, because in a way, instead of having to wait for year eight for material DPI to crystallize, we can actually start generating cash inflow. The moment the GPs starts deploying into their new companies, which actually starts paying back the original equipment that we made from day zero. So that's why we've been able to do what we do, and it's been an awesome learning experience today. - John, do you have, we have a diverse group of groups that are within our audience. And one is allocators and new allocators are people who want to build out new programs within their organizations. What advice do you have specifically for those corporates that are considering incubating some fund-to-fund practice? And it doesn't have to be specifically to like what, like for a bank, but any type of large corporate, what would you say they need to like think about to actually accomplish this? - 100%. The first thing that comes to mind is you need to be, you need to have top of the house alignment. And I kudos the leadership team of RBCX and the folks who eat our group who've gotten the buy-in of RBCL large to say, this is a dedicated strategy and platform that we're investing in perpetuity. And so having that buy-in at the top of the house, I think it's incredibly important. I think the other thing is like, understand where you have alpha, like understand where your strength is that potentially other folks don't. Like in the example that I gave, there's a lot of adjacent products and services and capabilities and strengths that RBC has that other potential allocators don't have. And vice versa, there's a lot of weaknesses and things that we don't have that other folks have. And I think the important thing is just understanding what can you bring to the table that makes your capital strategic and that your platform can help GPs be more strategic in their company building themselves. - The cross-pollination sort of how you can be, how you can be a good partner to so many different parts of the bank, I think sounds lovely. In reality, have you experienced, like what's the reality now that this strategy is sort of in motion? Are there any adjustments you've had to make or have you found like some things work better than others? - I think for us, it's worked really well. I think the way that we first started off was like, as we're building the RBCX practice, let's build anchor partnerships with some of the best GPs that we believe have access to some of the best deals in Canada. And that was kind of first and foremost. Then it was all about how can we support phase two is like how can we then support the underlying portfolio companies? So you have the relationship with the GP at the firm level, how do you support the underlying portfolio companies? And that's really through the products and services that the bank offers. The next lever that we kind of added there was like, how can we really support the GPs? And the GP is on the personal side, right? Like whether that's on the wealth side, whether that's on the mortgages side, like how can we build something that's relevant for those partners? And phase four, which we haven't necessarily built out yet, but what I really think about is like, how can we now really help the founders? Not necessarily on the professional side, but even on the personal side. Like if you think you're investing in some of the best GPs who ultimately are investing in some of the most brightest minds in Canada and abroad, and you know that some of those founders will potentially be some of the next high net refurners of the next generation from some of the best companies of the ultimately build, how do we help them make sure that we set them up for success in terms of the mothership of RBC when they ultimately do a liquidity event and we can support them through that wealth? So there's multiple layers to it, but I think at first it was kind of like, let's build the anchors, let's help them with their companies, let's support the GPs, let's support the founders. And I think that kind of four leg of the stools, how we think about it in practice. - Now we're gonna take a quick break to speak with our sponsor. - Next up, we have our industry expert and sponsor, Brian Huber, fun partner at Gunderson Detmer. Pitchbook has named Gunderson the number one law firm globally for investors 10 years in a row. Our guest, Brian's practice focuses specifically on structuring, forming and operating VC funds. I have used Gunderson in my own fund formation and I can highly recommend them. Thank you, Brian, so much for your advice and expertise. On the fundraising side, that is front and center for a lot of the people who listen to this show. We're recording June 2024. So is fundraising starting to pick up? - I would say yes. And medically yes, I say that both because I think it's true and also because I think saying it helps it to be true. I don't have empirical data that I'm basing that on. I have just anecdotally what I've been dealing with the past three or four months, which is a huge influx of calls from new clients and clients that may be paused for a little bit that are looking to reignite their launch process. And so we're seeing a lot of activity, I think. So there's sort of the activity associated with fundraising and then there's the on-pouring closing. And I think the next six months of this year are gonna tell whether we're really in a, it's here to stay or if it's just a blip and I'm pretty hopeful that it's here to stay. 'Cause I think a lot of folks that were struggling in the past couple of years with fundraising have had final closes finally and are already back at it thinking about what they're gonna do in their next fund, which is always a great sign. The resilience is something that is why I'm in this industry. And so I would say emphatically, yes, it's back. - Sure. - And there we go. - Are the more stylish firms having that much of an easier time than the emerging managers or is that? - This is something we talk about with clients all the time. Emerging managers, I represent a lot of emerging managers and it's been the past two years, three years. It's the most brutal fundraising market I've seen in my career. And I think I would say that more established managers are having an easier time but it's all relative. I think the easier is because they have existing loyal LP bases that they can tap into whereas emerging managers are starting a new relationship in a really difficult time where there's a lot of options. But to say it's easier, I would definitely not say that it's been easy. And I think one of the big things that's happened with a lot of LP's, institutional LP's doing with the denominator effect is that they're taking time to reevaluate what they have in their portfolio and their managers. And so I have a number of clients that had very loyal, very long-term investors who didn't come, didn't re-up for their most recent funds and it was a shock. And so nobody, very, very few people were immune from the tough fundraising environment. And so I would say that they might have it easier but it's certainly not easy. - Yeah, if you are working your way up the food chain and starting to talk to your first institutional LP's, what are some of those considerations you should have in mind for those new relationships? What should GPs be prepared for talking to the endowments, the pensions, the state sponsored entities? So yeah, the one thing that you will definitely deal with is more process, more diligence, deeper dive, they're gonna do very thorough review of your firm, your strategy, what your goals are. I think it can be disconcerting for a manager that's come from a relatively user-friendly LP base. And I say user-friendly in that they don't, it's not that the institutional LP's are not user-friendly, they just have a much more robust process. And I think that's a great thing for managers because it allows them to, one, prepare for those questions and usually what we'll do is we'll come up with our own almost like a test prep DDQ that can be used with external investors, but oftentimes it's just an internal talking points sheet so that when you are asked the questions, you've already thought about them. And I think that's the most important thing is to not, if you can't, to not have a question come up that you haven't already thought through. But I think what happens with the institutional investors is it really helps professionalize you as a manager because there's not gonna be a stone left unturned. And so ultimately they can be a really big cornerstone investor for your fund and that can also lead to more inbound requests to invest. But one thing that we also just sort of, I don't know if it's commiserate with or counsel our clients on that are doing their first institutional outreach is it's gonna take a long time, it's gonna, it's a months-long process in that, you shouldn't get discouraged by that, it's expected, it's gonna happen very rarely. And I think in some cases back in 2021, folks are moving quickly on anything and everything. And so, and that led to, that wasn't a good thing. And so just be prepared for it to take a little bit of time, it's gonna take longer than you expected, but don't get discouraged because, especially if they're going into the more deep dive analysis, you've already passed the first test so you should see, you should be welcoming the additional questions of building arms because it means that they're really interested in what you're doing. - Yeah, yeah. Well, and my experience was having the Gunderson teammates on that process also kept things moving along too. - Yeah, absolutely, absolutely. - Are there any things that you should be prepared for in the LPA too as you're working with more institutional investors? - Yeah, so a large part of it is gonna be reporting based or compliance based, I think reporting wise, it's hard to proactively set up your agreement to meet every need of every institutional investor 'cause they all work with their own script, they all have their own lists of things that they wanna get. And so it's really just trying to find a way to manage it all without scaring people away. I think the other thing- - Do those things all end up in side letters and that's where you expect them to be? - They do, yeah, they generally do because specifically on sort of reporting type stuff, it's very bespoke and it's a little bit different and for each investor, what we try to do is we try to massage the requests into something that looks similar across so that you're not having to reinvent the wheel each time you do a specific report, but that's generally where we would address it in a side letter. - And are there any other trends you're seeing that are more maybe LP friendly in the LPA? - LP, that's interesting. So I wouldn't, I think trend wise, I wouldn't say there's anything, it's funny 'cause there are trends that I'm seeing that are changes from, if I ran a comparison of our form right now against our form from three years ago, I wouldn't call an LP favorable necessarily, one of which is just based on a lot of things that have developed and across the globe, there's been a heightened focus in the industry on anti-money laundering, know your customer, KYC type stuff, and historically where you might've had a provision that says, we're gonna try to do as much as we can upfront, and by the way, the US, compared to a lot of other countries, is relatively lenient. I think that will change in the near future as we sort of get more into it. But I think, whereas a couple of years ago, we might've said, we'll do all our diligence on you as we're bringing you in, you're gonna make all these reps and warranties, and we have the ability to kick you out in a couple of months past the first closing, but after that, it sort of falls off the mat. Now there's much more robust rights for the GDP to kick somebody out if they're not compliant. And I think it's important because, and they tend to, and so I don't know that, I guess I would view that as LP favorable to everybody, but the LP that's not compliant. - Yes. (laughing) - Yeah. - Yeah, you're happy that the bad apples are not in the sun with you. - Exactly, exactly. I think, in terms of other things, venture does not, the companies that our clients are investing in are very innovative, and breaking the mold. The venture fund terms tend to not really change relative to some of the other industries, so you're still seeing the two and a half and 20, or two and 20, and 10-year term, five-year or five-six-year investment period. All that stuff is pretty much stayed the same. I think, so I would say that there's maybe not anything that's currently in form of LPAs that would necessarily reflect an uptick in LP favorable rights, but I do think that the LP's coming out of this tough fundraising environment are in a much better position to demand or to request, or to reevaluate what they're asking, and so it wouldn't surprise me if we looked, if we look in six months and maybe there's more reporting that's being done automatically, or I think those types of things could be where we're headed. - Yeah, Brian, it's been a pleasure to get in touch with Brian or any of the other lawyers at Gunderson-Dettmer. Please visit gunder.com, that's G-U-N-D-E-R dot C-O-M, and now back to our LP interview. - Can you share some of what your GPs are coming to you for personally? It's interesting to hear about the forms of loans, et cetera, what's trending? - Yeah, two things that come to mind. Very difficult for founders to get mortgages. I mean, the reason why Point Blank is they pay themselves very little, so it's very difficult to service the debt. So the way that a traditional bank would underwrite a mortgage to a potential individual doesn't really fit the archetype of a founder, because a lot of their net worth is tied up in their e-liquid company shares. And so how do you re-architect the underwriting criteria to allow mortgages to actually be available to founders? I think it's something that I think about a lot, and that we've been spending some time on. I think the other thing that's really interesting, and there's no necessarily solution to this, but there's a lot of times where founders want some level of liquidity themselves. And so the only opportunity for founders to get liquidity today is through the secondary market. But what that inherently does it, it caps their upside. And so let's say there's the example of an individual who wants to renovate their home or send their kids to private school or buy a new home, whatever they be, and they meet at $100,000 of liquidity. One of the things I think about is, how can the bank help through providing a liquidity loan as an example, where the founder doesn't actually have to take secondaries today, but can keep their upside, and we can help build that relationship from on the personal side, such that when they do ultimately raise on an external, when they do ultimately liquidate, that loan can be paid back. It's a lot easier said just like this versus when the nuts and bolts of all that get going. But those are two probably examples that I think about a lot that if we could solve would be really interesting, I think. - You, I can't even tell from this conversation in our previous conversation, you are an active learner when you're in a seat. And I'm sure you had a perspective when you were gonna become an allocator what that would feel like. What are some things that you didn't know but now you know that have kind of surprised you now that you're an LP? - Appreciate that, great question. There's two things that really stand out to me. One of them I think some of the audience could deem surface level by I think some folks would appreciate and one maybe a little bit more nuanced. You know, when you're in business school and you learn about venture, and let me say first, I think not all business schools teach venture but for those that do, and I think all should, what always gets discussed and the psychology of a business student when you hear the words venture capital have always been the relationship between the VC and the startup. But what doesn't get discussed and what you don't learn about is the entire business and relationship that is between the GP and the LP. And it is wild and it is crazy how opaque that is. And you almost realize being in this seat now, the entire kind of capital food chain that is venture. And the privileged position that I'm in is I get to see it from the very back and I get to see everything looking forward. So like when I first understood more about this business, I don't know if you've both seen Narnia but it was almost like I opened up a closet to Narnia and there was this whole world out there and I had no idea it existed. And it was just like really, really interesting. So I think the biggest learning that I had surface level was just like the capital food chain and venture and private equities at large and how it works on the LP side. - Yeah, the number of founders who don't realize that the VC they're pitching also has a pitch deck. - Yeah, totally. - Yeah, totally. - My buddies from college all started Docs End. And at one point, I got an email from Russ that said, Alexa, you're a power user of Docs End, why? Why are you in our top users? And I go, oh, I have a deck. I'm fundraising and it hadn't occurred to him that it happens higher up in the food chain, like you said, John. - So funny. No, it's so true, it's so true. And I think the other thing, just 'cause it's relevant, the other thing I think most people that I work with would consider me a data guy. I think that's just one of the things I like making decisions off of data. I think it's very helpful and objective. And I think one of the things I'd appreciate learning is just venture math, like adventure economics and how venture works financially and how the money flows. And I'll give you an example, like a lot of folks talk about these billion dollar exits and unicorn hunting, so to speak. If you look at the past decade, the median US venture capital backed exit over the course of the past decade was $140 million. And so take that into consideration. And so now say you're an early stage investor, maybe you bought 8% of that business on entry and you get diluted down 50% to 4% on exit. So you maybe generate $6 million in proceeds back to you on that $140 million exit. If your fund's 50 million bucks, you're generating about 0.1 DPI. To 3X your fund, you got to do that 30 times over or you got to find 30 times the amount of exit enterprise value to accumulate. If you were to do that 30 times over, you got to have five times the amount of shots on goal to account for loss ratios. So maybe you need 150 investments. If you have two partners, maybe there's bandwidth risk, right? And so it's kind of like, just like understanding all the different implications and nuances from certain decisions and understanding the business adventure. Again, I still consider myself a rookie, but like understanding how those decisions work, I think has been a hugely beneficial understanding asset loss. - Yeah, I think those are two great points because it's not just that relationship with founders and it's opaque there because they don't understand the other stakeholders that we are responsible for, to allocators. - Could we do a little? I am so curious, John, on fun math. Could we talk a little bit about where you've decided to focus as a result of that? - That's a good question. - Sure thing, yeah. It's something I think about when we talk about all the time at work. So why don't I talk a little bit about the difference that I think through, so we focus predominately on smaller funds. We typically do 100 million dollars, sub 100 million dollar funds, but there's been cases where we've gone above that. I'll give you the example of some of the just archetype that I see in terms of small versus large funds and then apply to Canada and kind of give you that nuance. This probably isn't new to most people, but the way that I think about ventures is there's two primary archetypes of investors. I think there's folks that are focused on assets in AUM and folks that are focused on MoIC or multiples. And I think understanding as an LP who you're speaking to is really important 'cause the underlying implications of that in return profile will be fundamental different. And I'll give you the example. Say you have two separate funds, you have Fund A and Fund B. Say Fund A is a 100 million dollar fund and Fund B is a 500 million dollar fund. Now, if you're the GP on the 100 million dollar fund, say you're able to forex that fund. You're take home, you would have made 20 million dollars in fees, 2% over a 10 year term, 20 million dollars, and then you would have made 20% of the 300 million dollar profit pool, which would have been 60 million dollars. So if you forexed 100 million dollar fund, which most GPs would probably be very, very satisfied with and LPs, you would take home 20 in fees, 60 in profits, so 80 million dollars in total. Now take Fund B, Fund B was a 500 million dollar fund and say you only 1x that 500 million dollar fund. You'd make nothing in profit as the GP, but you'd make still 20% in management fees, 2% over a 10 year term is 100 million dollars in fees. So what does that mean? That means you as the GP would make 20 million dollars more if you 1x a 500 million dollar fund than if you forexed a 100 million dollar fund, which I think is fascinating. And I think that's like the curious example of sometimes misalignment in venture and why it's really, really important to understand who you're speaking to, because though the GP in that case would make more in Fund B, the LP would make three times more of their money in Fund A. And so that alignment's key. Hence why at our group, small funds, sub-hundred million dollar funds has always kind of really been the focus. But I think it's important also to talk about the Canadian lens. And again, I'll kind of root this on data. Over the past decade I mentioned that the median US venture capital return, and I know not everyone's into the median, we're in for the upside in the asymmetry, but like go with me or on the median, 140 million is the median VC-backed return over the past decade in the US. In Canada it's about 95 million. What's interesting over the course of the past decade annually, it's roughly been 50% of the US exit. So Canadian exits typically have been on median half of what the US is exited for. There's very clear implications as to what that means from a Canadian perspective. The first is it's important that Canadian investors are very disciplined allocators, don't follow the heat, and can invest very early, and invest a good amount of capital early. And the reason why that's important is if you know your median exit value is technically lower than the US counterpart, you need to be able to come in early to still have the same asymmetry to generate a strong multiple, right? The difference between investing in a 10 million dollar post-money valuation and a 20 million dollar post-money valuation is half your return. So I think in Canada, going early is incredibly important. I think the other thing that's unique to Canada is capital efficiency is super important. And I'll give you another clear example, right? Like if you know 95 million dollars is the median exit value, if you think about the investor return on aggregate, if the target is a 10x, that inherently means that that 95 million dollar exit can only consume one 10th the amount of capital, right? Nine and a half million dollars. Now in the US side, if the US exit is two times larger, theoretically that US exit can consume two times the amount of capital for the same exit profitability. So what does that mean? That means that the Canadian market, we can't just follow what you folks are doing in the US or else our companies will be way over capitalized. And so we need to figure out how can we still get to the right exit values while staying capital efficient and trying to do more with a little bit less. And I think when you think past 2021 in the past few years where capital efficiency has really been the priority, I think that's been very strong for Canada because that's something that has really been ingrained in company building DNA and trying to understand, given we know there's less capital to the side of the border, how can we help our companies do more with less? And the third thing I'll mention, which I think is also interesting, is just with respect to fund size. Like, I think, you know, if you have two different types of exits in the same fund size, US and Canada, you know, the fund level returns will very quite considerably. And, you know, if you own 10% of that 95 million dollar median exit and you get nine and a half million dollars back on a 20 million dollar fund, that's 0.5X DPI on a 50 million dollar fund, that's 0.2X DPI. And so that the implications there are quite significant. So for us, for the nuances in Canada, investing early, investing in GPs that are focusing on capital efficient businesses and investing in funds that have kept their fund size appropriate to the scale of the Canadian market has really been where the group has focused today. - Do the grant making, some of the government grant making also seems to come in really early to help with that capital efficiency at super early days? Is there anything like that as you graduate to being a more mature company? - Not as much. You know, there's the growth capital in Canada is quite thin. There's a few folks that I'm sure you both know, like Georgian partners and Anovia who are very established and reputable partners. And the good thing about there being few growth funds in Canada is they get to see everything in Canada. But typically some of the best strengths that those platforms hold is the ability to also be the trusted boots on the ground for Canadian deals for foreign investors, specifically those also in the US. And so though on the growth stage side, there's less vis-a-vis grant and more on the other stage side for sure. The growth partners that we do have in Canada, albeit less than the US have done a great job being able to support local innovation. - John, it's really interesting you said that given the Canadian venture market is about 10, 15 years old. And then you went and said, "Hey, given the math and you went through it "and the median exit, "we can't do the same things that the US can do." That kind of broke my mind and I had to check myself because it was more of a like, "Oh, I'm having a US-centric approach of like, "Oh, since they're behind us, "then they can learn from all of our mistakes "and do it better." It's not that, it doesn't seem like it's that case. What other things do you feel that your market will have to zag where we zig? That goes along with that idea of, "Hey, we have to take less capital and do more with less." What other things are you seeing within the venture marketing, Canada? - Yeah, it's another great question. I'll try to emphasize a few things that are probably less spoken about. So I won't touch on AI or anything like that. But why don't we touch on fundraising? So this is capital raised by GPs from LPs. If you look at, and there was recent reports that were published recently, if you look at capital raised by GPs from LPs in the US market from 2022 to 2020, I think the figure is down roughly 54% in terms of capital value. And if you look at that in Canada, it's down 77% from our data. And so what that means is we're definitely on the same train, but our train is going down a steeper cliff. And the reason why that's the case is kind of goes back to that LP composition that I mentioned. When we don't have some of those big endowments and pensions investing locally, it just means there's a bigger capital gap to fill. But what's interesting is if you look at fund count, so that was a value. If you look at fund count between 2022 and 2023, the US is down 64%, Canada is down 30%. So what that means, interestingly enough is we've been able to raise more relative funds to where we were previously, but those funds have been smaller. And I think the reason why they've been smaller besides the LP point I made is really because I think GPs fundamentally understand that to invest in Canada, you need to apportion your fund size appropriately and still be able to generate strong returns given that small funds don't have strong fees and you make a lot of your upside on the carry, as well as the fact that exit values in Canada are just not the same as whether you're on the US market. So on the fundraising side, that's kind of one of the interesting dynamics, I think about a lot. I think the other thing is on liquidity side. And you mentioned this, but if you go back to 2011, as I mentioned, when our ecosystem really started getting going from an institutional perspective, it's been 10 to 15 years. You have a lot of late stage assets right now that are kind of on the sidelines. The next five years are gonna be critical for Canadian venture because I don't expect a lot of this liquidity coming in 2024. I still don't expect a lot of it coming in 2025. I think 26, 27, 28 are gonna be years whereby you're gonna have a lot of these companies that maybe were founded in the early 2010s, got their first findings, things in that kind of like 2012, 13, 14 era and gonna be some of the bigger names that have came out of Canadian venture over the course of the past few years. And what's interesting, again, from a data perspective, is if you look at the totality of aggregate exit value over the course of the past decade in the US market, relative to the amount of capital that's been raised by VCs, the ratio there is roughly 2.9 X. In Canada, that ratio is 1.7 X. And the reason why it's lower is because there's been less relative liquidity. And so I think liquidity is really important. And I think through that a lot. And the last thing I'll touch on with respect to Canada, which is really interesting, it's just like exit value to fund size. I know I touched on this, but like a little bit different take, funny enough, 2023 based on our data was the first year where the median Canadian exit, this was very strange, but the median Canadian exit was actually larger than the US median exit. So contracts what I just said slightly. And what's interesting now is not necessarily to compare the exit value in 23 to the median fund size in 23, but the exit value in 23 to the median fund size in 2013. To understand how funds to invest in these companies are ultimately gonna be able to generate fund level returns. So like if you look at Canada, the median 2013 exit value relative to the median 2013 fund size was 1.2 X. The median 2023 exit value relative to the median 2013 fund size is 6.9 X. And I think the implications there are really interesting as GPs think through, you know, folks making decisions on fund sizes today and capital allocations today are fundamentally underwriting to where they think exit values are gonna be in 10 years. Because if you look at where the majority of large exits have came in venture, we're talking eight, nine, 10, 12 years, like it takes a lot of time. So yeah, some of the unique takes on Canada, but super excited for the next five years for sure. - John, I have a follow up to that on the market. So, you know, I appreciate the median approach, but like we're in venture and we're all doing this for outliers. So for the outliers, one assumption I have and I'd love for you to respond to it is, you know, prior to the pandemic, I think the move to have regional small venture players to own certain regions, whether it's countries or parts of the US, was that we are gonna find the best companies and get that ownership before then they become coastal darlings, right? You said that with Shopify having a lot of Silicon Valley companies or firms invested in them. Did that change now for outliers? You know, now when we all realize we can do Zoom, been a flooding of like large funds, having seed programs and pre-seed programs, did that change kind of the math as well? And like, how do you think about keeping value and funds in Canada being able to have ownership in those outliers? - It's a great question. I think one of the things that, you know, started with COVID and continued on for the bull run was a lot of like border, everything was borderless. Like the amount of US capital that was invested in Canada was the, I don't have the date on this, but like I know for a fact, the spark was way high. Like it went from maybe 20% of all capital raise from Canadian companies was from the US, the US VCs and that sparked up to 50%. And so I think what that meant then was US investors were underwriting Canadian companies as though they were just typical companies, which may bring a little bit of risk if they go back to the kind of Canadian type exits. But I think to your point, Ernest, one of the things that's really interesting that we've been spending a lot of time on recently is Canadian life sciences. Because this is a very unique, unique space that's kind of very niche and specialized. I think it's actually a little bit overlooked. And I'll give you a very unique perspective here, but like the Canadian life sciences market, the amount of IP that comes out of Canada with respect to some of the research institutions and hospitals and academic institutions relative to the amount of capital that's available to fund those innovations is incredibly high, meaning the amount of capital available is very low. And so if you're a GP, focused on Canadian early stage life sciences and have some dry powder, you have access to a preffola of really, really interesting innovation. What's also interesting is if you take what I mentioned on the importance of Canadian investors investing early, a lot of Canadian life science investors actually focus on co-creation IP generation with the founding team. So they're literally like a founding partner. And what that means is they can literally command 20% plus entry ownership on some of these businesses. And if you can do that, regardless of where your exit value is, if you've kept your fund size appropriate, you can actually generate some really substantial fun lower returns just on that map along. - And they have the leader model. - Exactly, exactly. And the last piece I'll mention that makes your comment on specialization so unique is like, again, from a data perspective, if you look at the top 50 Canadian venture-backed exits in history, 13 of those 50 have been in life sciences. But which is quite remarkable, right? Like most people probably wouldn't think that, but Canadians definitely punch above their weight when it comes to life sciences. And if you think about then those 50 companies and you look at the aggregate exit value that they've generated, 40% of the aggregate exit value came from those 13 companies, which is remarkable. Which means that Canadian life science companies, not only can these investors invest very early, not only can they command very strong entry ownership, but they can actually get outlier type exits to your point, which makes that subset of venture specifically for Canada quite interesting to be spending a lot more time in. - Talking so much about the exit opportunities, what is happening in the next two, three, four years in terms of M&A and the IPO market? 'Cause here we've got so much antitrust regulation. What are the opportunities? What do you guys talk about in terms of your exit opportunities? - Yeah, it's probably quite similar to what you folks would talk about as well. I mean, like, listen, I think many, one of the other learnings I've had from just doing this for a few years is how cyclical venture is. And I think Bill Gurley has said it best in that venture you have these long kind of risk on periods and then you have these sharp risk off periods and it's almost like a sign curve. And the goal of venture is to be able to position your funds so that your portfolio can liquidate at the peak and invest at the trough. And I feel as though now, based on the data that I've seen, we're a little bit past the trough. I think the worst is behind us, I hope. But still, if you're a GP, now I think we can all agree is probably not the most opportune exit window to be able to liquidate your holdings just purely based on where pricing is. And so if you have the flexibility to probably wait a few years, given your companies can grow and sustain that timeframe, I think it gives GPs a little bit more leverage to be able to get more upside in some of these exits. What I think is really interesting, and I think Ernest may have mentioned this in a prior podcast, it's just like, there's a huge liquidity glut when it comes to the public markets. Like, our RBC group put out a report and it showed that there was 650 billion dollar plus privately held companies today. And even if half of those have those valuations that are warranted today, 325 companies, if you look at the sheer pace of EC-backed IPOs over the course of the past decade, it's like 20 to 30 a year, which means that you have a decade long liquidity glut. So like everyone would always speak about venture, the off-rance, the vector for liquidity for venture is the public markets. I don't know if that's necessarily reliable anymore for the next little while at least. And on the M&A side, one of the things that I've been speaking to a lot of our GPs about and seeing is like, anything over a billion dollars is getting significant regulatory pushback. So GPs are now thinking how can we liquidate and put points on the board on 100 million dollar exits, 250, 550 million dollar exits? And I think what's interesting there is, I think funds who've kept their fund sizes appropriate have the flexibility to do that. I think a lot of funds who raise at the peak and who still have a lot of dry powder and large funds probably don't have the flexibility to be able to take preliminary liquidity or to be able to actually generate fund level returns on single 100 million dollar exits or 500 million dollar exits because it just doesn't resonate in terms of their broader funds. So I think liquidity is a challenge. I expect it to be, I expect more cash outflows than inflows for venture at large over the next two years at least. And I think it's just gonna be a matter of trying to sustain and keep in the portfolio upright for GPs. - Are you actively looking to speak to managers and what's the sweet spot? Like who should reach out to you? - Yeah, appreciate that, absolutely. We'd love to. We'd love to speak with anyone building an adventure. I mentioned sub 100 million dollars on a typical sweet spot, but even if you're above that, I'm a student of the game. So still keen to learn and build relationships as you guys know, it's a very relationship driven business. So feel free to reach out at john.richtigar@rbc.com and always keen to connect. - John just wanted to say thank you for just your, you know, thoughtfulness, the data and just wish you the best in the programs you don't want to help any way we can. - Appreciate it. Thank you guys. It's a blast. - See you later, alligator. - After portfolio tile, investing with a smile. (upbeat music) [BLANK_AUDIO]
