Replay: Intro To Venture Capital & Private Equity Investing

Welcome back to the Invest Like a Billionaire podcast. Um, we're really excited about this episode. We're going to be talking about private equity and venture capital. Private equity is actually a very big holding of these institutional family office wealthy investors. And as we're doing the research, even larger than I had previously seen.

Right. And so our continuum shows basically that most investors, retail investors, are pretty much entirely in stocks and bonds, very underallocated to alternatives. As soon as you get up into the wealthier categories of investors, they start to get into private real estate. And even the bigger guys and more sophisticated guys are getting more into private equity and hedge funds. So it's kind of a continuum. The more, the more sophisticated, the more assets to deploy, the more you're into these other strategies. But it doesn't have to— there's no reason why guys that aren't billionaires can't emulate their allocation methodologies and get their outsized returns.

Exactly. And so, the continuum here— This is the Invest Like a Billionaire podcast where we uncover the alternative investments and strategies that billionaires use to grow wealth. The tools and tactics you'll learn from this podcast will make you a better investor and help you build legacy wealth. Join us as we dive into the world of alternative investments, uncover strategies of the ultra-wealthy, discuss economics, and interview successful investors. Looking for passive investments done for you? With Aspen Funds, we help accredited investors that are looking for higher yields and diversification from the stock market. As a passive investor, We do all the work for you, making sure your money is working hard for you in alternative investments. In fact, our team invests alongside you in every deal so our interests are aligned. We focus on macro-driven alternative investments so your portfolio is best positioned for this economic environment. Get started and download your free economic report today. You know, level 1 is kind of the stocks, bonds, mutual funds, standard portfolio. Level 2 we talk about is the real estate investing. That's where a lot of investors kind of the next step go to is the real estate. And then third here is private equity. And, you know, we have some cool data from Tiger 21, and this is a group of ultra-wealthy investors. You have to have at least $10 million of investible assets to be a part of this group. And they survey their members, which is over 700 members. So this represents at least, you know, $70 billion of ultra-wealthy investors' portfolios. And a huge portion of it is in private equity. And it is just about equivalent as real estate. So this is a big deal. This is a big part of what investors are looking at. And I think a big part of what the average high net worth is probably not as much into. So this is something I'm really excited to dive into. And a little bit of background on Bob and I, you know, so my background before kind of private equity world is as a banker and as an underwriter and a lender for several years and did quite a bit of M&A or mergers and acquisitions. Acquisitions, did several leveraged buyouts, um, also did some distressed, uh, financing.

So you've seen all these strategies we're talking about basically.

Yeah. So I've seen a lot of these strategies at play and, um, it's very cool. You've seen a lot of people make money and then you see a lot of poor deals as well. And so it's really important to understand, you know, what the strategy is, where we're at in the cycle and some of the different things that impact the strategy and the returns. And then Bob, you wanna share a little bit about your background as tech entrepreneur?

Yeah. So computer scientist by background and started a tech business in the late '90s that we got in one of the larger VC companies in the Midwest and the United States and became one of the fastest growing companies in the Midwest, United States in the late '90s and won the Ernst Young Entrepreneur of the Year Award. So I'm very familiar with venture capital and also, you know, with hedge funds because I also was a hedge fund manager for a while. So, so yeah, so it's a great space to be playing on and, you know, let's, let's dive in.

Okay, perfect. So first off, it's kind of helpful to talk about what is private equity, right? This is a term that a lot of people have heard and it can mean a lot of different things. And so very simply in the way we're going to kind of describe it is, um, you know, these are investors that are raising capital, uh, usually in a fund structure, um, that are investing in private companies with the goal to either IPO or do a public offering at some point, or to sell and be acquired to a larger competitor. And so very simply, that, that's what the strategy is.

I mean, really, it's the Shark Tank, right?

That's exactly—

that's private equity. So you're, you're basically buying a stake in these companies. So private equity is, generally speaking, passive. So you have managers who would deploy your, your capital So if Mark Cuban had a Shark Tank fund, you would invest in his fund and he would deploy it for you. So that's, that's the idea. But within that, there's a huge gamut of opportunities.

Yeah. And just as a quick aside, you know, a lot of people say real estate private equity, and that is technically true. And what we talked about in the last podcast, you know, that is a subset of private equity, but it's so large, it's kind of its own animal.

Right.

So we're talking about is investing in businesses and companies, not real estate.

So these are operating businesses. This is not a piece of real estate. You know, necessarily it's a, it's a business that's, that's doing some kind of operations and producing income, business income.

Right. And so, you know, if you're kind of new to this space as well, why should I be invested in private equity versus public equity, which is stocks? And, you know, we found some great research from Bain and Company, large consulting firm, and they've done pretty exhaustive research in comparing the returns of private equity companies and kind of their comparable benchmarks in the public markets. And the returns over the past 30 years on average have been over 13%.

Annual.

Annually.

That's darn good.

Very good. And then the comparable benchmark for that in the public markets was about an 8% return.

Which is still good.

Which is still great. And that's, you know, a lot of times people quote that number as the long-term average of the S&P of, you know, over the past 100 years or so. So that's within that range, but this is substantial outperformance. We're going to kind of dive into, you know, what these strategies are. And it's obviously, you know, pretty clear why investors like these strategies, right? You know, the biggest drawback— and we've talked about this in prior episodes— but is usually going to be liquidity. And that's for any kind of private market investment. That's going to be the biggest drawback. So you're kind of giving up liquidity for—

meaning you can't get your money back when you want it. It's locked up for a— it's in prison for a period of time, but it's in a very Very gilded prison, right?

So, and the reason it's locked up is these, these companies that execute these strategies generally have longer time horizons to execute the full—

you got to go do your IPO or find your, find your buyout. Now, you talked about these returns, but, but what, what you, what you didn't mention is that in the, in the last few years, the returns have not been that good, right?

Yeah. So if you look at the, the last 10 years, the outperformance is, is much less compared to the benchmark. And it makes sense. The last 10 years, the public markets have been on a tear, right? The annualized return has been very high. But, you know, there's a few things there. One, on the long-term average, the stock market has not sustained those levels of returns.

Right.

So if you look at it at a broader scope, it's—

so it's not fair competing against the S&P 500 for the last decade because it's been ripping.

Right. But But the other side of it is because of these returns, it has attracted more capital. And just like we're talking about now, to introduce these strategies to newer investors, the regulation changes have allowed the floodgates of capital to flow into the space. And so it is important to look at these with, you know, a little bit of a grain of salt and realize that, you know, timing is important and there's a lot of capital looking for good returns. So, you know, with that, let's kind of jump right in. And the way we've kind of broken this down is kind of the easiest way we think to describe it is really by the business cycle. So if you have a business background, you understand kind of the stages of business at a large scale, right? It's the early stage, your startup stage, growth stage, mature stage, and then declining distress stage. And, you know, over the long haul, most businesses go through some level of this cycle. And there's different strategies involved with each stage of the cycle. Right.

Different strategies that apply to businesses in that, in that stage.

Right. So let's just jump into the first stage, which is early stage. And so this is where most people hear the term venture capital. That's most of the time where they're going to be playing is in this early stage company. It's going to be a company that many times is pre-revenue. Um, they maybe have some level of a prototype of a product or software, but it hasn't been fully tested, um, at a large scale. And they're going to raise money from venture capital firms, angel investors with the hopes of making it big. So talk a little bit about kind of the strategy here. You have some experience here.

So yeah, so it's minority ownership. So the idea is a a venture capital investor generally does not take over the company. They just simply add a board seat. Usually there's multiple rounds. So actually different— there's, there's in within this early stage, there's actually different, different, different stage of venture capital. You got, you have venture capital that loves seed stage, which is literally two guys and an idea, you know, all the way to really mezzanine stage or pre-IPO stage. And it's all considered venture capital. And they, they, they, amount, you know, invest different amounts of money. It usually gets larger over time and at higher valuations, but less risk. Exactly. And so typically what they'll do is they'll come in and do an A, an A round, a B round, and a C round. There's 3 separate rounds of financing that are a year or more apart generally. And the idea is each one is bigger, higher valuation, and preparing you for your eventual exit, which is either a strategic acquisition or an IPO. So these are generally fairly high-risk companies. And so the strategy is basically to go for moonshots. So the very first guy that invested in my business was actually a very well-known venture capitalist and is with one of the very early venture capital firms in the '80s and was one of the most successful. And he said this was their strategy, that they, they look for 1 in 18 of their investments in their fund. 1 in 18 has to hit, and they only, they only look for companies that have a potential of doing a 100x, a 100x investment. So it's, it's a moonshot, and, and that's their strategy. And, and basically, so if they get a double in any of their, any of their companies, they get a double or a triple, it's, it's a wipe. They, they couldn't care less. They're only looking for the 100xers, and pretty much everything else they just they just X out of. Right. It's irrelevant. It's immaterial to them. And so that's the strategy. Look for 1 in 18. And they had super high returns during their heyday. They were returning over 100% per year to investors. You know, now those returns haven't been sustained. But if you look at the top quartile, according to Cambridge Research, the top quartile of venture capital firms have produced around over the last 10 years or so have produced between 15% and 27% annual returns. So, yeah. On the other hand, the bottom quartile, the underperformers, they're single digits. Sure. You know, so, so it's, it's typical in this, in this stage. There's a lot of, you know, you know, the good guys, the guys who are very good at this are, are just killing it. And so, so very, very high returns potentially, but also, you know, a fair amount of risk. I will point out it's very cyclical, too, you know, so So almost all of them rely on a very active and hot public market. Even the strategic exits, they're looking at the strategic players. So the big strategic buyers usually are accessing public funds. So if the market just had a big crash, you see all of this kind of fall apart.

Yeah.

So what happens is in the business, as the business cycle the broader business cycle continues, the time to invest in VC is at the beginning of the business cycle, near the bottom of the business cycle, or as we're just emerging into a growth phase. So, during the March 2020 COVID pandemic, there's nobody doing IPOs. There's nobody, there's not a lot of activity. Everything is just seized up. The markets are just seized up. Same as in 2008. 2009, 2010, there is no activity. VCs are not— they're basically sitting on their capital trying to figure out what to do because that kind of thing. So, those are actually good times to get started knowing that in 5 years you'll have a good exit as the markets recover potentially. So, you want to be early to mid-cycle in investing in VCs, in my opinion.

Right. It's just a quick sum up. So, at this stage is higher risk because You know, these are early companies, haven't been proven at a larger scale, but the returns can be very substantial. A lot of times that 1 or 2 winners will pay for all the ones that didn't work out, and usually well above what you did not capture on that. So kind of the next stage here is really growth stage. And this is still, I would consider venture capital because it is more minority ownership, and maybe it's a later stage of the fundraising, you know, a Series B, a Series C. And so the idea here is it's a company that's been proven, so they've they've got revenue coming in, they got customers, they're growing healthfully, but they want to scale faster. And so if it's in a particular industry where it's harder to protect your IP, if it's tech or something that it's, it's beneficial to scale faster, they will partner with a growth equity firm that will come and invest alongside and usually again in a minority way and help them scale faster and So one of the things in both of these stages is a concept called cash burn. You want to kind of break down what cash burn means in these stages? Okay, I can. So cash burn is effectively these investors come in and add more capital and the goal is growth, so they'll go and hire more employees, they'll go and spend more in marketing, and they'll basically load up the expenses to where they're running at a net operating loss. But the hopes is that they're generating— try and generate top line, generate enough, enough revenue, and then at some point that'll catch up and you won't need the capital that, you know, funded the, the cash burn for a while. So that's, that's very common here. And something that, you know, in your experience, you know, with this VC firm and your past company was kind of the strategy, right? You were growing. Oh yeah. Yeah.

You start hiring everybody you can and, and, you know, the burn rate just goes to the moon. But also the revenue does. So, right. So yeah, that's the strategy. And it's so it's either, it's either you land on the moon or you flame out, you know, and there's no middle ground, you know. Um, but that's, that's their model, right?

So a lot of times firms at this level, they can be a little more creative in the types of financing. So if it's a, you know, more well-established company, maybe they'll come in as a debt partner or as a, you know, mezzanine debt, which we'll talk about those in a minute. Um, but they're not taking as much of the upside, but they may charge kind of higher interest rates to, to the companies, but then they don't have to give up as much equity. And so you kind of see different strategies at play here. You know, one kind of very common strategy is what is called the roll-up strategy, which is kind of a cool concept. And you want to break that down a little bit?

Yeah. So it's very common. So when you have a fragmented industry, I've seen several strategies here that just are great winners. You know, that happened with accounting firms, lots of little accounting firms, and CBIZ came in and started buying all these little accounting firms to build really what's become an accounting giant. Client at this point. And then now, so you take these small firms and they're heavily discounted to the market. So if this little accounting firm was actually public, if it was, you know, 100 times bigger and public, they would get much higher multiples on revenue, right? Or earnings. Yep.

Okay.

So private companies are heavily discounted. Their multiples are very low. Right. So typical private company, multiple might be 5 or 7x, means the company is valued at 5 or 7 times earnings. In the public markets, it's 20 to 30 to 40, or if you're Amazon, 93. Or Tesla, 1,000. 1,000. So when you access public markets, the value of the company goes up dramatically. So the idea here is to roll up smaller companies and use the private company discount to assemble a stable of very good smaller companies. And so one strategy was, like I just said, the accounting firms. Another one I've seen these guys hired, they basically bought kind of the leading car dealership. You know, these are high cash flowing businesses, but too small to go public. They bought the leading one with the best systems, the best processes, the best automation, the best everything. And they paid a higher multiple for that company. And then they went and did an acquisition strategy to buy up all the little smaller guys at much lower multiples. And then use the management team of the, of the first one to basically replace the management or the operations of these other little ones and to build a very large conglomerate of, of car dealerships that, that had, had the excellent operating characteristics of the first one they did. So it's basically a finance play. It's a finance engineering play. You have access to this, this cheap financing to buy all these companies. You create a nice exit for these mom-and-pop operators. But you create a, you create a huge amount of value. I mean, you could create hundreds of millions and billions of dollars in value just by doing this strategy. So it's called a roll-up strategy. Very common if you pick the right industry and you have the right timing. So great, great money can be made there.

Yeah. Yeah. So it's obviously a little bit less risky than, you know, the early stage because these are established businesses. Um, so you're not necessarily banking on the home run, you know, and one of 18 or whatever. You know, kind of more I call good solid doubles. You're hitting really good doubles and, you know, a lot of value can be created as you achieve that scale. You know, not only do you get more operating income, but you also expand, right, the value based on the multiples that are being paid at the larger level. So a lot, a lot of firms kind of play, play in that stage. Kind of the next strategy is, is what we'll call the mature stage. And so these are large companies. They are not high growth at this point. They've either kind of achieved market saturation. They're well-established brands. A lot of times they'll even be publicly traded businesses that then get taken private, but they have strong cash flows. And so because of the cash flows, you can do a lot of things with it. And if you have a strong cash flow in business, then it can attract a lot of cheaper financing, like from banks. And so a lot of times what they'll do, the strategy here is usually twofold. And it's either financial engineering or operational.

So this is a leveraged buyout is what you're describing here.

Yeah. So the most common way that they execute a strategy in a mature business is a leveraged buyout. And so effectively what that means is, you know, if you understand real estate, it's a very similar concept where you are buying a company with both equity and debt. You bring the equity and then you work with a debt partner like a large bank or debt provider.

And because there's cash flow in this business, you're using the cash flow of the business you're buying to basically get, get a lot, get a lot of cheap debt.

Yep. A lot of cheap debt. You can already cover the debt payments from that. And then any increases in value that you create have a multiplying effect because of that debt's not taken to the upside. And so it's a multiplying effect to the equity.

Just like if you bought real estate on and that real estate has a 5% return. But if you, if you leveraged it up and you only put 20% down, well, you got way higher than a 5% return. Because of the leverage. So it's that kind of a deal.

Exactly. Exactly. So that's, that's the financial engineering side of it. Um, and the other side of it is, you know, operational efficiencies. A lot of times these companies get, they get big, they can get bloated with the expenses and, you know, staff and technology and other things. And so, um, you can kind of bring efficiencies if you have, um, you know, an experienced management team in a certain vertical or certain, you know, business segment that they've done this before and they can operate these businesses And the other kind of big differentiator at this stage is when they're doing a leveraged buyout, they're not coming and taking a little piece of the business, a minority stake. They're actually buying the whole business and operating it. Right. And so it's a very different set of risks because this is a full operational strategy.

Right.

And so generally you want to find sponsors and funds that have experience in certain verticals. And because of that, a lot of them will specialize in verticals.

And I've actually seen where a lot of these bring their own management teams. Yeah. So they have, they have the guy that's done, you know, X number of these. Who's the, who's the, who's the awesome food guy, right? Or the awesome, you know, IT guy or whatever he is of this industry that knows this whole business. And so it's like a full-on head transplant here where you go in, you know, throw out the old guys, bring in the new team and take, take this to the, take it to the moon. So depending on these strategies, you know, there can be some great wins here. As well in the LBO space, you know.

Right. Yeah. So, and then that kind of leads us to, to the next part, which is the declining and distressed stage. So, you know, a lot of times, you know, the mature stage, they're— they haven't, you know, they're not on a downward trend, but they're not having huge, huge growth. But at this next stage, this is really where companies are maybe past their heyday, right? Right. And they're looking for some help, right? Do we You know, how do we turn the ship around and right this ship? And it's a much, you know, it's again, majority ownership generally. And it's you're operating the business and you have to turn around a company. So as an underwriter, I'd seen several of these and it's, it's risky, right? Because what are the current management doing that is not working? Right.

And what is the new management going to do that's going to change all that?

It's going to change all that. But it depends on where you're at and what the business cycle and what types of business you're going after. But one kind of interesting concept I've seen in this space is there's a guy who is raising capital for a fund that is going and buying well-known retail brands. So he's buying like Steinmart, RadioShack, you know, these names that everybody knows but are kind of on their last leg. And he buys them for pennies on the dollar.

Right.

And then his background is as an e-commerce, uh, you know, doing a lot of e-commerce business and, um, helping businesses scale online. And so he's—

so he does a high-tech, uh, turnaround for these things.

Exactly. So he uses the existing brand awareness, um, and leverages that online to help turn his businesses around. And he picks them up for super cheap, and the goal is to, you know, get a nice multiple when, when these businesses pick back up. And so that's another, you know, very interesting strategy that some will play in. It's obviously going to be very specialized in the business segment you're going to be in and make sure you can operate a business.

But you can make money in any and all of these strategies. The key is finding great operators. And as an investor, knowing, knowing, you know, hearing the story and believing the story that this is the right timing for this kind of, this kind of opportunity.

Yeah, yeah, we kind of said it all along, but, you know, these strategies can be applied to a variety of industries and a lot of times there'll be multiple industries that you can use different strategies in. But, you know, it's not just the big high-tech companies. It's manufacturing is a very commonly targeted PE focus because it's, it's a boring business, it's high cash flow and it's generally not going to go anywhere anytime soon. Right. So there's a lot, a lot of ways that you can play in this space. Let's talk a little bit about structure. So this is, you know, we've talked about the overall strategies and how, you know, firms execute them. But the next question would be, well, how do I invest in these? What are the best ways to kind of get involved in private equity? And that's kind of what we want to talk about now. So really, the first kind of easiest way to get in, I would say, is angel investing, right? That's a term maybe some have heard. And it's very simply, you know, generally individuals, sometimes groups of individuals that are going to go and invest in a company. And a lot of times it's going to be earlier stage at this point because they're writing out as big of checks as maybe a big PE firm would. But they are a lot of times going to come in as an advisor if they have experience in this type of business and a little more hands-on. And, you know, a lot of times there's, you know, local angel investing groups. Local groups you can get involved with that you can invest in local companies. And so it's a really cool way if you want to be more actively involved. You know, angel investing is a great, great thing. We know a lot of people that are actively involved, you know, that are investors with, with us in Aspen, and they've kind of hit a point where they're financially set, but they want to give back and help other people be successful and in their businesses. And so it's really a cool mentorship, but also financially rewarding way to invest.

Yeah. You know, the problems are there. You know, you get in a high cash burn business and you bring in a little bit of money and you realize that they need a whole lot more money and you realize that, you know, you know, so you're not the be-all end-all and you don't have a controlling interest. So, so a lot of these, a lot of these don't have good outcomes, you know. And so if you're going to do individual angel investing, you better know the deal and you better, you better have a pool of these things, you know, a large, large group. Because a lot, a lot of times this doesn't have good outcomes.

Exactly.

In my, in my experience.

Yeah. I mean, so tread carefully. And obviously if you're going to be investing in individual companies, you lose diversification, right? So, you know, it's a principle of investing where you don't want to have all your eggs in one basket. And it's important if you are doing these kind of individual investments, do smaller amounts and spread it out across.

And I would only touch areas that you're actually familiar with.

Right.

So if you're a biotech guy, then do that. If you're a tech guy, then do that. If you're not any of those things, don't touch them because you really probably should let someone who's qualified do those kinds of deals. So, yeah, you can make— and it can also be a time sink. It can take a lot more time than you really want to put in. These are generally very needy businesses and high-stress businesses.

Right. Yeah. The next level would be crowdfunding. So, you know, if you have ever looked into angel investing, you know, very common place that people look now is AngelList. This is basically an online platform where businesses that are looking to raise money will go and put their business, their deal up there, what their valuation is, how much they're looking to raise, and try to attract individual investors. Right.

And AngelList actually has experienced VCs who who run their own little funds and you can put money into them, uh, you know. So, so to, to get with the big boys, the guys with the top quartile, you know, um, you, you know, probably have to write a, write a much larger check, right? And, and very difficult to get in those things.

Sure.

Um, so, but AngelList has some less known VCs who, you know, I don't know where they would fit in the, in the, in the return range, right? But there's literally— they have their resumes up there and their, their returns, and you can You know, there's dozens of them you can pick. Okay, I'll follow this guy. And, and you can even do monthly subscriptions. They call them the rolling funds. So, so kind of a, you know, a small players, uh, smaller players way to play in the angel world. And they also have their own, their own fund, their own, right, the AngelList-sponsored fund. Yeah, that they do.

So obviously benefits of doing that, you know, at AngelList they have a very wide array of options, right? If you're if your deal flow is limited because you're not in this space actively. It's a great way to see a lot of different types of deals, you know, how they're, how they're raising, how they're being valued. And like you said, you can invest alongside experienced VCs. So you can kind of use that as, hey, all these guys are jumping in. It's, you know, probably, probably got some potential. Um, but some of the downsides are, you know, you're, you're gonna, it's gonna be harder to do due diligence on a company that's, you know, at that level. And you're usually going to be a smaller player, a smaller fish in the pond. So you're going to have less impact on the overall financial decisions and operational decisions. And so you're kind of going along for the ride, but, you know, can have some great outcomes there. And that kind of leads to the next way to—

what is SharesPost?

SharesPost. Yeah, I found this one the other day. So this is kind of a similar, similar deal, but it's basically you're investing alongside of VCs and you can be a small sliver of the capital stack. So I think it's similar to AngelList. Another one is OurCrowd. It's another one I found recently. It's very, very similar. So all these are kind of different parts of the—

Now, where's the one— there was one where people that had options and shares of pre-public companies were actually listing them for sale. I thought that was interesting. I think that was SharesPost.

Maybe that was. Yeah.

So you see, if you want to buy a share of Dropbox before it ever went public. You could buy it, but you don't know, you know, that's risky too, right? You know, they might have a stinky IPO, or they may not have an IPO, but right, you can buy the shares usually at a discount to par because the person needs liquidity, and so they're willing to— or at a premium because they're greedy. So either way, you never know.

But right, yeah, yeah. The other one is probably the most common way, you know, if you want to get in this as more of a passive investor, which is really what we're targeting with, with our audience, right, is how do we How do we diversify across a lot of different asset classes passively and not have to have the brain damage of operating these deals?

Yeah, and this is generally the way to go is you get super experienced operator who has a very well-defined strategy, clear target, all the, all the staff and analysis to do this right. And those are the guys that win generally.

Yeah. Yeah. So this is again investing directly with a private equity fund. And so again, you're going to leverage the experience and the expertise of a sponsor that has a great track record, that's been in this particular space for a while. They get all the deal flow, they get all the best terms and financing. They're, you know, have all the staff in place to help execute these strategies. And, you know, that's generally going to be the best way to go as you're kind of getting into this. And again, it's just more passive. And a lot of times they're going to raise a fund that's going to invest in a lot of different companies, right? Anywhere from a handful all the way up to a dozen to two dozen. And so you get a lot of diversification that way too, when these firms are investing and spreading across several that are going to—

you know, excuse me. You're going to pay their fees, but generally they're worth it.

Right.

Right. I mean, if you get the right guy, they're bringing massive amount of expertise and they're going to create a massive amount of value through their expertise.

Yeah.

And you get to sit back and watch and get some passive returns.

Yeah. And the numbers we quoted earlier on the Bain Company's research, was net of fees.

Right, right.

So it's, it's, it's clear that even with paying maybe an asset management fee or whatever fees they're going to charge are going to be, um, it's going to be worth it, you know, from a net standpoint. So, um, you know, some of the cons though is, is, you know, if they're raising in a fund, a lot of times it's a blind fund. You don't know what, what target companies they're going to, you know, invest in. And so you don't have a lot of visibility into the exact portfolio companies that they're going going to be.

It's a blind pool.

It's a blind pool.

So, so you either do all your own due diligence or you find the team and let them do it and you pay them to do it.

Right.

Yeah. So it's, it's really your risk profile. What do you, what do you want to do? You kick the tires kind of guy, right? You know, or are you, you know, I'm going to hire the right guy, right? Let them kick the tires.

Right. And really the next way to invest in private equity is really, you know, a subset of investing with PE funds because this is, a fund of funds. And so the concept is you invest with a manager that has a fund that then goes and invests in other PE funds, right? So not even investing directly in companies, they're investing in other funds. And so this is even another level of diversification, right? To where it's not only diversification across the portfolio companies, but also different strategies. So maybe they're going to do some leveraged buyouts, maybe some early stage, and they can kind of mix and kind of plug and play where they want.

And, and you would think, gosh, why would you add another layer of fees? But, but again, you know, in, in my, my research, these guys can do a really good job. They actually do a better job because, one, they know who the better players are.

Yes.

They also have a macroeconomic view. Yep. So they may say, well, based on our, on our timing of the IPO market, we need to heavily weight towards this type of fund or this type of fund, right? And I know who the managers and operators are, the sponsors in those areas. And so it's not, they generally earn their keep by making, these are more of the super brainiacs who are doing the real analysis of all these different funds. And they can generally get pretty good deals. We know how much sponsors sometimes give sweetened deals for capital groups, capital piles. And so it could be you're adding layer fees, but you're getting a discount from what the other investor would get. So it's not an automatic don't do this. In fact, I would say it's a great strategy. You know, generally, probably it's the larger investors that are going to go for the fund of funds kind of guys.

Sure.

But it's a good option there, you know? Yeah. You know, and I'll say this too, as we're wrapping up on this, that, you know, I had my venture capital friend, he said, here's our investment axiom is we always invest not on the horse, but we, we, we don't, we don't bet on the horse, but we bet on the jockey.

Right. Yep.

So, so they're looking primarily for an operator that has the certain profile and track record, et cetera, versus that particular business plan or that, that, that, that particular deal. And I would say it really throughout this whole, all the strategies, all the structures, that's really the best strategy is find the jockey you believe in. Not necessarily the vehicle. You may like one particular deal more than another particular deal, one particular investment or something else. But really the best way to pick, in my opinion, is to find the best operators and let them do their thing. And so that's just a common axiom that's kind of time-tested.

Yeah, absolutely, absolutely. And really kind of the last, you know, points we want to make here. We addressed this in the last episode, um, in real estate investing, and it's very similar. But, you know, the capital stack of, of, uh, this can kind of be overlaid across any strategy that a particular, um, it's like 3D chess now we're playing, right?

Exactly. So our, our continuum is more like 3D, 4D here.

Yeah, so there's so many ways you can slice and dice this, but, but generally, you know, there's going to be You know, the equity funds that are going and playing, um, on the equity side of, of the capital stack.

And that's where your shareholder, you're an owner in the shares of the business, who's the last guy to get paid generally.

Yeah.

Or you can go up the capital stack to, to the, to the debt side as well. So there's, there's venture debt and there's growth debt and mezzanine debt.

Yep.

Yep.

Yeah. So, you know, there's senior debt as well as junior debt. Mezzanine debt is generally going to be junior debt and They will charge a high interest rate, but they also may take some of the upside, but it's not going to be as much upside as an equity investor. And so, if you are looking at these types of funds, pay attention to where they're at in the capital stack, because obviously, the higher up you are, the closer you are to debt, the less risk there is, because you're first money out, you get paid first. And the farther you are, closer to the common equity, the more risk you have.

And I would say too, it's like the more sophisticated investors are, the more they like the debt space.

Right.

And, and, and, you know, and the less sophisticated investors love the equity. Hey, let me play for the upside. But, but the reality is the debt guys structure deals so that they always get paid. They get paid first and they get paid most. I mean, it's just, it's like, pay me, pay me, pay me. And, and, and they take, they take far less risk and they can earn really good returns. And then they can take a chunk of the upside to the deals they cut are sometimes crazy good.

Right. And right.

And where there's far less risk and almost equity-level returns. And yeah, so, so, so, you know, don't, don't, don't not do a debt fund because you don't think there's enough upside.

So yeah, if you compare a debt fund as opposed to debt and a real estate property, they're very, very different. I mean, debt funds and private equity can be making double-digit returns, both from kind of the interest rate they charge as well as any carried interest in the profits.

And so, so, so just for example, let's take a, take a private equity, you know, growth private equity company and you're doing a mezz debt. So, you know, maybe you're getting 10 to 15% on the mezz debt. Maybe it's a junior debt. But, but you understand there's how many assets are in play here. So it could be your debt is 100% secured by the, by the building that they own. Sure. And the, and the— you follow me? So you're earning almost the same level returns But far less risk. Far less. And you understand, you know, you understand the senior mortgage or the senior debt in front of you. You understand. So even if the jockey does a lousy job, you're going to make money because you're going to be able to take the assets. Right. And so it's not a, you know, hey, don't look at this just because it's debt. In fact, it's the other way around. So I find the more sophisticated players are, the larger players are, the more they love the debt space. And the more they, they, they, they tooled, they tooled that, they basically changed the debt around. I had, I remember arguing with my, with my venture capital guys, you know, back in the day and, and I would argue for certain valuation. You see, you know, you always want to argue for the entrepreneurs, argue for a higher valuation. The, the, you know, the investors are arguing for a lower valuation to put the money in at. And I remember one of the venture capitalists laughed at me and said, tell me what valuation you want. I'll give you whatever valuation you want as long as you let me write the terms.

Exactly.

And so then they put all these different covenants and terms and, and levers and triggers and other things.

And for the evaluation was kind of—

exactly. And I learned a thing or two. Yeah, you know, so these guys are financial wizards, a lot of the guys that are structuring this stuff. And they— it's structured that heads I win, tails you lose kind of deal. So from an investor's point of view, there's some huge wins in the debt space and mass debt space.

Yeah. The last thing I want to just hit here real quick is you mentioned this at the beginning, is that a lot of these strategies work better earlier in the economic cycle, right? And so, what would you say kind of where we're at in the economic cycle and what What areas of this would you jump into or would you wait? Would you kind of see if— we are arguably at the later end of a business cycle, but there are a lot of things happening with the federal stimulus and other things that are prolonging this economic run.

Right. Well, and this is a very— it's a great question and a very weird cycle.

Sure.

And every cycle is different. That's why this isn't a check the boxes. Type investing and requires thinking. And really, the business cycle kind of bottomed in 2008, 2009. And we've been on a tear pretty much ever since. Of course, we had a very, very slow growth where you saw the— just looking at the unemployment rate did not recover during the Obama years. And just we could barely— so it was not much of a recovery. So, I would say we were we were still in the bottom even, even through, you know, 2013, 2014, 2015 timeframe. So then what happened is things really started to, to shift and all the, all the stimulus started really trickling down and it started working. So we were, we were early, early, early stage of the business cycle there. Then COVID hits, March, March 2019, and everything crashed. And so kind of reset the cycle again. And so we're still now, as we're in recovery, we're in early— we're in kind of bottom cycle with a caveat that there is a ton of money because of the stimulus in the public markets.

Right.

So it's kind of an early stage but hyped stage. And so I think really, honestly, I think all these strategies would— it's a good time for these strategies. IPO market is still hot as can be. You know, it will see if that continues. So, you know, we again, you know, my, my forecast is we're going to see an upward bias in the markets, but a lot of volatility in the public markets. And since that's the source of all the capital generally for, for everything used in all these strategies, you know, if there's a hiccup, things generally slow down. Right. But at this point, I think we're not yet at the, at the end of the cycle. And simply because of the one, we had the COVID reset and then we had this massive stimulus happening. In addition, it's, it's putting more fuel on the fire.

Right. And a lot of these strategies can be executed in shorter time frames, you know, 3, 5, 7 years. And so especially if the strategy is on the shorter end of that, your risk from a cycle standpoint is limited as well.

Yeah.

So awesome. Was a lot of information. Hopefully that was kind of helpful to break this down. You know, in the future we are going to be interviewing guests that are operating in this space that either run funds that are doing private equity strategies, venture strategies, and so we're pretty excited to get some of those guys and gals on board and talk more about this. Stay tuned for the next episode. We're going to be talking about hedge funds. This is kind of rounds out our big three on the alternative investment continuum, and we'll kind of be breaking down what, what those look like. And thanks for joining in.