Mark Suster: Why Private Equity Will Replace IPOs and M&A as the Exit Path | E1147

Intro (0s)

• Mark Suster, a venture capitalist, discusses the current state of the tech industry and the overvaluation of companies in 2021.
• He mentions that the market correction is likely to last for another five years.
• Suster also acknowledges the ongoing conflict in Gaza and the hostage situation, expressing his support for peace and the release of the hostages.

Entry into Venture (3m0s)

• Mark Suster entered the venture capital industry in 2007 after selling his second software company to Salesforce.
• He was initially hesitant about becoming an investor but was encouraged by his mentor, Eve Sisteron, to join as a general partner and actively write checks.

Founders vs. Operators (4m6s)

• Founders who turn investors understand the journey from 0 to 1 better than operators turned investors.
• Founders have a unique understanding of the psychological challenges of being a founder.
• Effective entrepreneurs and venture investors must be able to compartmentalize problems and deal with stress.
• Many people cannot handle the stresses of being a founder, especially those who come from larger companies.
• Losing money and taking write-offs are difficult for anyone, but there are worse things.
• Some entrepreneurs are not good people and can turn bad, leading to threats, lawsuits, and fraud.
• In one case, a founder embezzled millions of dollars and the VCs settled, getting back the stock but not the money.
• Such cases are often kept secret due to legal agreements.

Navigating Challenges with Experience (8m22s)

• Fundraising is challenging, but persistence and belief in the team, opportunity, and market can lead to success.
• Leaders should shield their teams from fundraising stresses and pressures.
• "No's" come quickly in fundraising, while "yeses" take months.
• Some LPs hesitate to commit due to fear of making a wrong decision, leading to mixed signals for entrepreneurs.
• LPs form opinions of entrepreneurs based on multiple interactions over time, not just one meeting.
• Surprisingly, few LPs invest without existing relationships.
• Private equity is becoming a more popular exit path for startups compared to IPOs and M&A.
• Investors commit to venture capital firms based on their track record, resilience, and decision-making during challenging times.
• Persistence and a proven track record, as demonstrated by Mark Suster's experience with Morgan Stanley, can lead to successful fundraising.
• A strong first fund as a managing partner can significantly impact fundraising success.
• Building trust and a positive reputation with investors can lead to faster and more successful fundraising in subsequent rounds.

Founders' First Close Strategy (15m36s)

• Raise the minimum amount needed to close the round.
• Create a narrative explaining why you closed on a smaller amount.
• If raising $100 million, close on $20 million and deploy checks.
• Explain to investors why they should commit before others.
• Offer incentives to the first investors, such as extra carry or a discount on fees.
• Closing on 20 out of $100 million may look like failure.
• Put the smallest number on the pitch deck to avoid this perception.
• If closing on 20 out of $50 million, it's still not ideal but better than 20 out of $100 million.
• Strategy doesn't fundamentally change between a $50 million and $100 million fund.
• Adjustments may be made, such as the number of investments and check sizes.

Institutions vs. Personal Networks (19m26s)

• Institutional money is more likely to be available for subsequent funding rounds compared to friends and family money.
• It is advisable to seek institutional investors for fundraisings, even if the investment amount is small.

LP Influence in Fundraising Dynamics (20m44s)

• Mark Suster, a prominent investor, shared his investment strategies and experiences.
• During the 2008 market downturn, he bought stocks of stable companies like Verizon, Altria, Dupont, Microsoft, Google, Amazon, Morgan Stanley, Goldman Sachs, and City Group, which proved to be profitable when the market recovered.
• In 2018, anticipating a market decline, he began selling positions and sold $1.2 billion worth in 2021 when valuations were high.
• In 2023, he took advantage of market fear by purchasing secondary shares at discounted prices.
• Suster typically sells a portion of his positions (33% to 40%) during market rallies but maintains long-term holdings in companies with strong growth potential.
• In a private equity deal, he decided to take $150 million off the table while keeping $200 million invested long-term.
• While some limited partners (LPs) questioned this decision, the majority (70%) were appreciative and understanding, although a few LPs were openly critical.

The Misconception of IPO Liquidity (25m49s)

• Private equity firms are emerging as a significant exit option for startups, offering rational prices for acquiring assets from venture capital funds.
• The influx of private equity investment has led to a surge in unicorn valuations, with over 1,200 companies valued at $1 billion or more in 2021 and 2022, but many of these unicorns are not legitimate and may never achieve a billion-dollar exit value.
• Seed funds are also facing challenges with low DPI (distributed profit to invested capital) and high TVPI (total value to paid-in capital) due to the irrational markups of private equity firms.
• Overcapitalization in the tech industry can lead to both positive and negative outcomes, and the current overvaluations of 2021 suggest a potential for a longer correction period.
• Despite the recent correction, there are still instances of irrationally priced deals, particularly in AI companies, where high premiums are being paid for generative AI startups.
• The cost of launching a startup significantly decreased in 2009 due to the introduction of Amazon's AWS, leading to a surge in startup creation.
• SpaceX's Falcon 9 rockets have reduced the cost per kilogram to launch into space by over 90%, resulting in increased space-related startups and investments.
• Los Angeles is becoming a hub for hard tech Founders working on projects that weren't feasible a few years ago.

Investors’ Transition from Software to Hard Tech (38m13s)

• Investors are shifting from software to hard tech, including infrastructure and energy.
• Hard tech and software are fundamentally different, and investors need specialized skills to succeed in hard tech.
• Multi-thematic funds with specialized teams focused on specific themes are more effective than concentrated funds focused on a single theme.
• Healthcare, once considered a challenging sector for venture capital, is now yielding strong returns for investors.
• There are fewer public market exits for traditional space companies, but the majority of space activity involves satellites and communication, such as Earth observation, media, and telecoms.
• New use cases for space technology are emerging, such as mineral extraction and zero-gravity manufacturing.
• Investors should be concerned about exit environments for all ventures, including software companies, as there are limited buyers for large, privately held companies.

M&A Landscape Evaluation (40m10s)

• Private equity is likely to replace IPOs and M&A as the primary exit path for startups due to increasing regulatory scrutiny and challenges in acquiring large companies.
• The optimal exit range for startups is between $250 million and $1 billion, as there is a larger pool of potential buyers in this range.
• Entry price and valuation discipline are crucial for venture capitalists, as they impact the potential returns on investment.
• Venture capitalists typically reserve a portion of their fund (usually around 58%) for subsequent funding rounds in promising startups.
• Mark Suster believes that "rocket ship" companies with huge early traction are not sustainable value generators and that it's difficult to pick winners early on.
• When considering follow-on investments, Suster looks at three things: continued belief in the market, continued belief in the team, and the valuation.
• Suster emphasizes the importance of the right people in the right market, with a 70% focus on founder-driven investments.

Biggest Investing Mistake (48m33s)

• Mark Suster made a mistake early in his career by investing too much money into a fast-growing company that eventually failed.
• He learned from this mistake and started being more disciplined about reserves and planning.
• He realized that his ego had driven him to make the mistake and advised his partners not to let ego get in the way of making investment decisions.
• Suster believes that younger investors who have never raised money can be dangerous because they may not fully understand the difficulty of raising money and driving returns.
• He advises new investors to be patient and look at many deals before deploying capital.
• He believes that richer investors may make better investors because they are not as scared of the downside and have an upside maximization mindset.
• Suster believes that hardware plus software can provide a differentiated return, despite many people disagreeing with this view.
• He cites the example of Ring, a hardware company that was initially passed on by Shark Tank investors but later became a billion-dollar exit.
• He acknowledges that Amazon and Google may have eventually entered the market anyway, making it too competitive for Ring to remain independent.

Concerns over Potential US Election Outcome (52m59s)

• The speaker raises concerns about the rise of the extreme right and left, particularly the radicalization of the latter against Jewish people.
• The speaker highlights the historical persecution of Jewish people and their acquisition of their ancestral homeland through purchase in the late 1800s.
• The speaker criticizes the far-left for villainizing Jewish people, who have historically been among the most oppressed people in history.
• The speaker draws parallels between the current rise of anti-Semitism and historical instances of oppression against Jewish people, such as in Russia during the Bolshevik Revolution.
• The speaker questions the sudden emergence of anti-Semitism among white middle-class students and suggests that it may be a passing trend rather than a deeply held belief.
• The speaker condemns Holocaust denial and emphasizes that Israel is a democracy that welcomes minorities and women in leadership roles.
• The speaker criticizes the far-left's attempt to villainize Israel and suggests that universities need to find more effective ways to manage activism on their campuses.
• Parents are revolting against Harvard, Penn, and Columbia, forcing changes in education.
• Education should be a place where all ideas can be explored without targeting any specific group.
• Jews are facing marginalization at Columbia to an absurd degree.