Jordan Stein from Cresset Partners on VC dynamics, evaluating emerging managers, & more! | E1901

Jordan Stein from Cresset Partners joins Jason (0s)

• Compares the chances of winning the lottery and investing in venture capital, suggesting that venture capital is a better investment.
• Proposes the idea of scratch-off tickets that allow people to invest in venture capital.

Cresset Partners’ motivation for investing in venture capital (1m12s)

• Cresset Partners, a multi-family office founded in 2017, offers institutional-quality private investment opportunities to its clients.
• Cresset Partners waited until they reached $20 billion in AUM before launching their Venture fund to attract top-tier funds.
• The firm has grown primarily through organic growth but also through acquisitions and mergers, such as True Capital Management, which brought in a strong roster of relationships in the Venture Capital space.
• Cresset Partners aims to provide exposure to top-quartile VC managers for its clients and external investors as part of a diversified asset allocation strategy.
• Venture Capital firms are attracted to athletes and celebrities as investors, which helped Cresset Partners gain access to top-tier funds when they launched their Venture fund.
• After gaining access, Cresset Partners was able to secure investments from Andre Horwitz Founders Fund, FPVC (first reinvestments run by West Chan), Lighted Ventures, and Cowboy Ventures.
• Jordan Stein from Cresset Partners emphasizes the importance of building relationships and being part of the venture capital community.

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The state of venture tourism (12m45s)

• Despite the market downturn in 2022, well-established venture capital firms like Founders Fund, FPVC, and Craft Ventures continued to receive strong support from limited partners (LPs), while newer firms faced challenges in fundraising.
• The market has seen an influx of "venture tourists," including hedge funds and other investors who entered the venture capital space during the market boom, potentially contributing to unsustainable valuations.
• Venture capital firms are managing the impact of overvalued rounds and markdowns by working with their clients and GPs to navigate the challenging market conditions.
• Jordan Stein, from Cresset Partners, emphasizes the importance of maintaining a consistent allocation to venture capital, despite market cycles, to capture both up and down cycles.
• Stein sees significant opportunities in artificial intelligence (AI), similar to previous technology trends, and believes top-tier fund managers are well-positioned to capitalize on these opportunities.
• Cresset Partners has a co-investment program that allows them to invest alongside their managers.
• This program exists because managers understand what the winners are and have more money to deploy than Cresset Partners.
• Cresset Partners looks for emerging managers with a differentiated strategy, a strong team, and a track record of success.
• They also consider the manager's investment philosophy, process, and culture.
• Cresset Partners believes that emerging managers can provide superior returns because they are more nimble and have lower fees than larger firms.
• The venture capital industry is constantly evolving, with new trends and challenges emerging all the time.
• Cresset Partners believes that it is important to stay up-to-date on the latest trends in order to make informed investment decisions.
• Some of the current trends in venture capital include the rise of artificial intelligence, the growth of the healthcare sector, and the increasing importance of ESG (environmental, social, and governance) factors.

Cresset Partners’ co-invest program (21m25s)

• Co-investment programs are gaining popularity among fund-of-funds strategies, with firms like Cresset Partners allocating a portion of their funds for co-investment opportunities.
• Co-investments offer advantages such as reduced fees and faster distributed paid-in (DPI) for investors.
• They also provide access to deals that general partners may not fully invest in due to concentration limits or other constraints.
• The venture capital industry operates in an asymmetric information environment, where private companies do not publicly disclose their information, creating opportunities for informed decision-making.
• Seed investors take on high-risk bets and pair their positions, while later-stage investors seek those shares.
• The public market and co-investments are part of the venture capital ecosystem, which follows the power law, where a small number of investments generate the majority of returns.
• Predicting successful investments is challenging, even for experienced investors, so venture capitalists manage entire portfolios, considering the power law and risk when making investment decisions.

Jordan's perspective on the Power Law and risk-taking in VC (29m26s)

• Venture capital (VC) has a power law dynamic that makes it difficult to predict winners, especially at later stages.
• Later-stage funds invest in established companies and have less potential for extreme returns compared to seed-stage funds.
• Seed-stage funds, like Chamath Palihapitiya's $8 million fund, have a higher chance of generating significant returns, as seen with companies like Instagram, Uber, and Twitter.
• Concentrating ownership and conviction in a few investments, as demonstrated by Orin Zev, can lead to upper echelon returns.
• Founders Fund has a notable ability to identify and heavily back potential winners, such as Airbnb and SpaceX, resulting in significant returns.
• Emerging managers offer less volatility and solid returns, complementing established larger funds.
• Jordan Stein from Cresset Partners emphasizes the importance of evaluating emerging managers and constructing a portfolio with a mix of emerging and established managers for a strong risk-return profile.
• Startups are currently facing challenges and must adapt to the changing landscape.
• An emerging manager is defined as a venture capital firm that has raised less than $500 million in total capital commitments.
• It can be challenging to evaluate emerging managers because they don't have a long track record or multiple funds to assess.
• Look for managers with a strong team and a clear investment thesis.
• Consider the manager's experience, both in venture capital and in the specific industry they're investing in.
• Evaluate the manager's track record, even if it's limited.
• Look for managers who are well-networked and have access to deal flow.
• Consider the manager's fees and terms.

How Cresset Partners evaluates established and emerging VC managers (35m47s)

• Cresset Partners focuses on emerging managers with a track record, often those who have spun out of institutional players.
• The firm evaluates managers based on their ability to identify opportunities, win investments, and their network and reputation within the venture capital community.
• Cresset Partners conducts thorough due diligence by speaking with references to assess managers' capabilities and potential.
• Jordan Stein from Cresset Partners invests in 24 funds, including his own, and focuses on seed-stage deals where competition is less intense and there is more room for negotiation.
• Stein emphasizes the importance of having a clear decision-making strategy and doubling down on promising investments.
• He uses a framework to evaluate emerging managers, considering factors such as revenue, investor interest, and inbound introductions from top-tier funds.
• Stein defines "likely winners" and "definitive winners" coming out of the seed stage based on criteria such as having a party round with multiple leads or being backed by a known VC firm.

Jason's framework for distinguishing "Likely Winners" vs "Definitive Winners” (43m2s)

• Cole multiple co-leads one person a convertible note in the likely winners, a priced round in the definitive winners.
• In the likely winners, there may not be a governance change or board meetings.
• In the definitive winners, there are three people leading the round, a couple of angels, and they do a convertible note.

Cresset Partners’ goal of democratizing wealth management and VC access (43m45s)

• Jordan Stein of Cresset Partners discusses venture capital dynamics and evaluating emerging managers.
• He proposes a theory to categorize startups into "likely winners" and "definitive winners" based on growth, round dynamics, and governance. Definitive winners are rare but signal strong potential and attract significant investment and board seat interest.
• Contrarian investing can yield high returns, and having a strong lead investor with conviction can indicate a contrarian view.
• Data-driven firms like Goodwater Capital seek overlooked opportunities beyond traditional founder profiles.
• Extreme product-market fit, or "market pull," is an exciting indicator of startup potential, characterized by rapid growth without significant marketing efforts.
• When evaluating seed-stage startups, it's crucial to talk to customers and ensure proper governance. Not engaging with customers and neglecting governance are major red flags, especially in the crypto vertical.
• Founders should focus on understanding their customers and validating product-market fit before seeking investment. The "painted door test" is a useful concept where a minimum viable product is created to gauge market interest before fully launching.
• Stein emphasizes the need for democratization in venture capital, as current regulations make it difficult for non-accredited investors to invest in top-tier venture firms. He suggests implementing an accreditation test for investors to ensure they understand the risks and potential rewards of venture capital investments.