← How I Invest with David Weisburd
How I Invest with David Weisburd
E120: Why Bigger Isn’t Always Better in Private Equity and Venture Capital w/Teddy Gold
00:22:50
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- [00:00]
A
People will raise good results on 10, 15, $20 million of lending into these nicher strategies. And then scaling that strategy to a hundred, two hundred, three hundred million dollars is harder. It's hard to scale a team, it's hard to scale the infrastructure. It's also hard to get the quality deal flow you had when you were a smaller fund. And once again you run into the problem of scaling strategies. So I think over time there's going to be a washout. I think the returns are going to be diluted on some of these private credit strategies. So much of what we do at 3 I is understanding where our members are expert, tagging them in an internal database and then spending time with them. One of our members spen lifetime in aviation finance, buying and selling engines off of plates. And in typical 3i fashion, after getting to know him, he just called us one day and said he's personally investing into the teardown of a particular engine, a CF680, which is used on Boeing 747s and 767s. We funded our first deal alongside that member in the space and members made their money back in less than 12 months and 1 1/2 times their money in 18 months. After getting to know the sponsor, we funded our second deal with them, which was acquiring three engines from AerCap for a total of 14 million million. Two of them to lease, one of them to tear down.
- [01:07]
B
So what is 3i?
- [01:08]
A
3I is an investment network. We're not a fund or a bank, but a community in its truest sense. Our members are all exited founders, traditional family offices and fund managers who leverage this network to source and co invest in private equity deals and private credit deals, find experts and ultimately, and we hope, learn from each other. The Insight that launched 3i in October 21 came from my co founder Mark Gerson, who previously founded the expert network glg. And you know Mark and from his own experience and I think inside of what I would call a very entrepreneurial family office, Mark faced this frustrating reality that sourcing high quality investment ideas and these are the types of things that can Yield in the 20s on IRR with limited downside was achievable but entirely random, right? This is just a function of who you happen to meet at whatever random reason for at whatever random time, or who you happen to see that week. So like you did with glg, where they put a very valuable process, vetting method and system in place, in that case sourcing experts and tapping the unused inventory in people's brains, we Follow a similar suit here at 3i and leverage the untapped potential on our members balance sheets, in their email inboxes and in their portfolios to find the interesting deals that can create a community and system which is purpose built for really surfacing great capacity constraint deals, applying the expertise of the network for better diligence and fee breaks and ultimately compounding all of what I think are the hard earned sort of life hacks and wisdom from a career of success in investing in business.
- [02:31]
B
How many members are you at and how much have you guys deployed?
- [02:34]
A
Since launching In October of 21, we've grown to 550 members and deployed a little over $500 million. And if you, I think, rewind the clock to the early days of 3i in 21, it was a unique time for a couple of reasons.
- [02:48]
B
Right.
- [02:48]
A
The pandemic is starting to tail off. There's this exuberance in tech and crypto. The family office world is booming. So McKinsey says the number of family offices is up from just doubles between 2018 and 2021. And the private markets are exploding. Right? So you go from $5 trillion of private market value in 2013 to 11 trillion by 2022. So I think in that time in 2021, we're at the start of what I saw and Mark saw as a real revolution in how investors find deals. I think we're moving away from traditional banks and brokers and starting to rely more on personal networks. And it's a shift from trusting institutions to trusting peers. Edelman does this great annual trust survey which tracks trust levels in everything from scientists to media, and recently found that peers are the only group where trust is continually on the rise for the last five years in a row. Now overlay this onto investors, especially family offices, investing in sort of diving into private deals for the first time. This means they're increasingly comfortable sourcing deals from their own networks, bypassing sort of the traditional wealth manager or RIA or bank. But there's this real challenge where you lack the resources and structure.
- [03:51]
B
How do you know that you're not being adversely selected in the deal flow?
- [03:54]
A
I think it all comes down to our filtration mechanism and what we aim to become is an easy place for a member to send a deal that they've been sent or a friend might be looking at but they don't know what to do with. By sending it into three I, you can get a sort of quick look from another member expert within the network and a quick yes, no of is this an interesting deal to be looking at. So I think if you were going to be looking at a deal alone, you can now bring the institutional back of 3i and the 550 members expertise in I think sourcing. Not only sourcing deal but doing diligence on. Is this interesting to be looking at.
- [04:27]
B
And is there a value add component to that? I know a lot of opportunities may not want to have a lot of LPs. Is there an upside to having so many members in one deal?
- [04:35]
A
So it's the process we run that makes life easy for either the company or fund that we're investing into. So we'll streamline in our investing process the sourcing of the deal. So we'll host very structured intake calls to understand what the company or fund does. Those are usually shepherded by the member who's putting forth the deal and planning to invest in it. Two, the diligence is very structured so we will open a centralized data room, centralize all Q A and then for the deals that we're investing in will be very Again, we put a strong structure against the amount of calls and the way that we're tracking information. So from the LP for the GP side or the fund manager side, it feels like they're dealing with one institution. But on our side we can help shepherd and coordinate between all the members who are invested. And the reviews we get from GPS are very strong. We can raise at this point between 35 and $50 million on average into a deal. And the process takes somewhere between two to three weeks.
- [05:22]
B
What are you able to raise more for and what are you able to not raise as much for?
- [05:25]
A
Twice a year we'll survey the membership on what are the types of deals and asset classes they're interested in. Like I mentioned early 24 that was private credit and specialty finance. Later 24 that's venture and private equity secondaries. Most of what we've done on the platform, it's 60% of the deals on the platform. We've done about 50 deals now. 60% of them have been into funds and 40% of them have been in direct deal opportunities. What has turned out to be the sweet spot of 3i is an emerging manager who is willing to part with early GP or seed economics to gain the backing of our network, which can provide early business development for a fund or a deal advisory and ultimately be the anchor or seed in for example a fund, one that's lending against government contractor receivables who's on path to raise 100 million. We can be the first $30 million in and then that fund will go on to raise, you know, additional $200 million on top of that and to go on to success.
- [06:14]
B
So you're able to solve for first check, first fund. What are you guys looking for in first time fund managers?
- [06:20]
A
We're unique in that we're not an institution and we're not a fund. So we don't have a dedicated mandate as defined in an LP agreement. What members are looking for is the ability to gain, like all investors are outsized economics for taking limited risk when it comes to emerging managers. In specific, what's been attractive about the value proposition for emerging managers is by working with our community to gain access to early business development help by leveraging our network and also an advisory board that they can build out of our network and they can go through a lot of the early fund raising process and by building infrastructure with the members who've been through the process before and can act as an advisory board for them.
- [06:55]
B
I'm curious, do you have ways to de risk your investment in being the first first check into a first time fund? Do you have structures in place?
- [07:02]
A
We're not always the first checks into first time funds, but the way that we de risk the deals that we're working on is through an asset management process that I think is unique for family office investors. So if you overlay what a good fund does well, it's three things. They source well, they do diligence well and they asset manage well. The family office or ultra high net wealth individual can source well because they all have individual networks, but really they have no structure or framework for the latter two. For doing diligence and for asset managing. By clubbing up the community as a group and by acting as a single funding source. Even though our members are investing individually, we can apply leverage and we can apply the collective pressure of a 30 or 40 or $50 million check onto the GP or CEO of the company we're investing into. And one of the things we started in 2024 is an asset management process where we get regular updates into the fund or company we've invested in twice a year. And we'll use those calls to make sure that we are using the network we can to the best of our ability. We're using the network to help stack the deck for success in the fund or company we've invested into.
- [08:00]
C
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- [08:30]
B
You mentioned a breakdown of trust in large institutions like large investment banks. What is the cause of that?
- [08:36]
A
All of our members are traditional family offices, large fund managers or exited entrepreneurs who know how the game is played. And our members are extremely fee sensitive in the fact that they know what that there's a lot of extra juice in the traditional 2 and 20 and they're skeptical of first of all, anyone charging that full rate fee and second of all anyone who's charging above and beyond. Mainly because all of our members have either been in those shoes of playing the role of asset manager, have worked with asset managers, or have sold companies using banks and intermediaries and I think understand how the game is played. So because our investors are sophisticated, they're unwilling to part with the traditional economics that I think have made the asset management industry as a large generalization over bloated. So what our members are looking for is direct access onto cap tables if it's a direct company by bypassing the venture manager who's charging SPV or access to a fund on preferred economics. If they're willing to take risk while the fund is still small, our members will consistently say I'm tired of seeing the same old product from my RAA or wealth manager. I'm interested in seeing the early stage fund that has a compelling business opportunity, has found an interesting arbitrage, but needs their first slug of institutional capital to take a real swing at it. Or a company that is willing to be creative in their financing, that doesn't want to work with an institution that's going to be overly burdensome on either the diligence process or the terms they're going to take.
- [09:57]
B
You mentioned that your members know how the game is played. Talk to me about how the game is played when it comes to institutional investing.
- [10:04]
A
I mean, I think it's well reported and you've talked about it on this podcast with some of your guests is that great fund managers often become asset collectors and often turn into asset managers where, you know, the 2 and 20 is a really lucrative model when you're collecting billions of dollars and you're you can live a luxurious lifestyle, you know, have a great office, hire a successful and sophisticated team on, you know, tens, if not Hundreds of millions of dollars of management fee. And I think that there's a real conflict of interest there where funds have to grow, they have a mandate to continue growing their fund size over time. And that I think accrues negatively to the benefit of the investor. And you've seen over time the private markets overperform the public markets. But if you really break down that data, it tends to be in the earliest funds. Right. Funds one through four do much better than funds five through ten. And the problem with investing early is Morgan Stanley or Goldman Sachs or UBS has too much demand from their investors to be the first check into a hundred million dollar interesting credit fund. There's a scale problem. So where our members can be opportunistic and flexible is by gaining access into and willing to roll up their sleeves on a subscale $250 million, for example, private credit strategy that's run by a promising spin out of Apollo or Blackstone, who understands the rules of the road, who understands a niche vertical very well and can earn you an 18% unlevered without taking the sort of onerous fees and onerous, you know, netted out returns of a larger institution.
- [11:30]
B
Yeah, I think there's a couple aspects that hurt performance. One you highlighted aum. Some strategies should not grow. Some strategies are scalable. You've looked at what Blackstone has done and they've scaled several strategies and continued returns for far beyond what many people expected. But other strategies like venture capital are not inherently scalable because there's only so many great seed and series A opportunities. I think the issue is not actually on the fees. I think it's on the AUM side. Some of the best performing funds that you would kill to get into in venture capital are actually 2 and a half and 20 or 2 and a half and 25. They're just impossible to access. I think the other issue you highlighted with the large banks is that is this kind of principal agent problem. And what do I mean by that? Large banks make their money by not losing clients money. They're not optimizing on gaining alpha for their clients. And if there's even a 10% chance that that client might lose money, even if there's a 90% chance they might make a lot of money, they don't want to take that risk, which is why they go with the KKR fund 15 versus the spin out that you mentioned. So those are the kind of things, kind of the principal agent problem in the AUM gathering. I actually have a contrarian thesis. I was speaking to one of my mentors, longtime mentors, who's starting a family office and I advised them to go to the top venture capital funds and side letter higher fees to get into them. I actually believe in paying fees for the best products. But to your point, if you are coming in early, you should get a fee break and you should really avoid the large AUM players.
- [12:58]
A
Yeah. And I think particularly on some of the. We went deep in mid 23 and early 24 on specialty finance and private credit funds and we're not the only group to get interested in this asset class. But on a, for example, on a 12% bridge lending fund and there was one that was particularly attractively put on the platform, a reduction in management fee and a reduction in performance fee can get you from, call it 12% net on a, you know, very safe and a safe bridge lending fund, you can go from 12% with a reduction in fees that you become 14, 15% on a bridge lending fund by taking very little risk. And that kind of fee reduction is very material. Now on venture, I'd argue that it's a different story and you should be willing to pay fees to get into the best deals and you shouldn't be fee sensitive. But on a reliable and underwritable private credit deal, a reduction in fees is a material difference, particularly for a family office that's thinking about either cash alternatives or income streams and netting using some of these investments as income. So I think while some of our members are not fee sensitive, I think the vast majority of them increasingly are, particularly on products that are promising returns in the teens where a point or two or three on an annualized return can make a huge difference.
- [14:10]
B
You mentioned you really double clicked on specialty finance and private credit. Where were some of your learnings from that asset class?
- [14:16]
A
I think there was an exuberance in private credit when the banks tightened on the backs of Silicon Valley and Signature and First Republic. There was an exuberance in private credit. A lot of the local lenders, and there's a very well known and documented constriction of lending from some of the regional banks that were underwater in some of the commercial real estate lending that they had done. So in this opportunity popped up. You know, this is where Wall street works well and capitalism works well, is that in a drought of capital, early managers will go into lend to government contractors or beneficiaries of USDA bridge loans or you know, small businesses that need access to capital. And you can make an attractive risk adjusted return by investing in some of these niche or asset classes that were previously served by regional banks. So there's a lot of guys that promise really interesting returns on some of these strategies. The problem is some of these strategies are less scalable than they promise to be. So people will raise, you know, have good results on 10, 15, $20 million of lending into these niche or strategies and then scaling that strategy to 100, 200, $300 million is harder. It's hard to scale a team, it's hard to scale the infrastructure. It's also hard to get the quality deal flow you had when you're a smaller fund. And once again you run into the problem of scaling strategy. So I think over time there's going to be a washout. I think the returns are going to be diluted on some of these private credit strategies. But some of that's still to come. And honestly very dependent on where rates head.
- [15:35]
B
We were chatting Last time about 3 I buying an aircraft engine. Break down that deal for me.
- [15:40]
A
So this is a great example of how our members source together due diligence together and then ultimately invest together. One of our members spent a lifetime in aviation finance buying and selling engines off of plates. And in typical 3i fashion, after getting to know him, he told us and just called us one day and said he's personally investing into the teardown of a particular engine's a CF680, which is used on Boeing 747s and 767s. We funded our first deal alongside that member in the space and members made their money back in less than 12 months and 1 1/2 times their money in 18 months. After getting to know the sponsor, we funded our second deal with them which was acquiring three engines from AerCap for a total of $14 million. Two of them to lease, one of them to tear down. And this is just a good illustration of what the 3i membership is best at, which is, you know, we tag and understand our members expertise very well and we try to stay close as possible to their deal flow. And when we get signal from one of our members that they are investing heavily alongside the same terms available to everyone else into a deal that they know and understand and love, our antenna go up, we activate the membership and in the case of the second deal with the same sponsor, we mobilized a little less than $14 million in 48 hours, which for us was the big first proof of concept that the 3i membership, though it's in, in aggregate 550 members, can actually act like a fast and nimble institution by streamlining some of the diligence processes and streamlining some of the feedback processes with a sponsor to very quickly fund deals. And we're now establishing a great relationship with a sponsor on the other side of this. And we have a first look at any aircraft engine teardown or lease deal that comes their way that fits within a certain buy box for us. So I think these aircraft engine teardown deals are a perfect example of the 3i process. And in aggregate, we've done 55 deals now, not all aircraft engine tear downs, but some of them. And for a little over $500 million.
- [17:30]
B
In aggregate, you see hundreds of deals every month. And do you see the cyclicality of supply and demand of capital into deals, meaning certain spaces are very interesting, like aircraft engines, and then everybody piles into them and then in a couple years the trade has gone. Do you see that happening across asset management?
- [17:45]
A
Absolutely. It's a true an adage as ever about particularly investing into these opportunities. There's an arbitrage, for whatever random reason an arbitrage exists in the market and there's a significant yield to be earned by being the first money into an asset class like aircraft engine teardowns. Bigger money always listens and finds it. And as people pile on, they drive down the returns. So while we were excited about aircraft engine investing two years ago and last year, I think you're starting to see some bigger capital flood back into the space. And as such, the returns will be driven down. And where we always want to be listening to and why we design our biannual asset interest survey the way we do is we want to understand where members, we want to skate to where the puck is headed and we want to understand where members are going. So a year ago that was, hey, we are starting to get interested in venture and private equity secondaries, which is why we've done a couple of deals there at the beginning of this year. Now we're seeing a renewed interest in real estate. And I think we're going to start, you know, there's some really interesting opportunities in distressed real estate in office in New York City, for example, some of the themes that you've heard about. We're always trying to stay ahead of the trend by surveying our members of what's the asset class, that is, what's the sparkle in your eye that we can go and source for you in and leverage some of the expertise in the membership to get an advantage on.
- [18:52]
B
Double click on your surveys. Are you looking for where there's consensus? Are you looking for where there's a 15, 20% member interest rate. How do you know where the puck is going?
- [19:02]
A
So much of what we do at 3 I is understanding where our members are, expert tagging them in an internal database and then spending time with them and covering them. I think investing is a contact sport. It's just a matter of, you know, spending time getting to understand our members, understanding where their expertise lies, and listening closely for the moment that they gain signal only when it's in a place that they have legitimate expertise. So in the example of the aircraft engine teardown, the member who brought us that deal which has performed, both of them have performed very well. This is someone who has true vertical expertise in aviation finance. If that member came to us and said, I have a distressed commercial real estate opportunity, we wouldn't listen as closely. So in that survey, it's our job to find the signal. When a member who has deep expertise in an industry says, hey, I think there's an opportunity emerging here, that's when we perk up and that's when we listen.
- [19:51]
B
If you're successful, where will three I be in five years or ten years from now?
- [19:55]
A
In membership networks, value accrues to scale and the value of a network increases with every incremental valuable node. So we have really one job at 3i which is to continue adding extremely high quality members. Everyone is either a family office, a fund manager, an exited founder, everyone has been referred by an existing member. And as we grow, it's our job to maintain and actually increase the quality bar as we go. So one of my goals is to build density in our main hubs, that's New York, Miami, San Francisco, Los Angeles, Chicago, London and Toronto. We have on the ground presence in all of those major cities and we want to create a vibrant enough ecosystem where we have regular event programming. So the goal over the next three and five years is build density in our main cities, add super high quality members, and ultimately grow the network with people who can be additive to and accretive to the network at large.
- [20:47]
B
What are some early mistakes that you made as CEO of 3i?
- [20:50]
A
I believe that investing and relationship building and fostering and creating a network are both, they're contact sports. And I think there's a misconception in startups that everything you have to do is scalable. And in the beginning days I was really deeply focused on did we have the data infrastructure that could scale with our membership? Did we have the event programming that could scale with our membership? Did we have the deal intake methods that could scale with our membership? Did we have the technology and people and processes that could scale? But what I sacrificed in the earliest days was the relationships with our earliest members, which are ultimately the most important thing we have. So what I corrected the team's mentality towards and my own mentality towards, which is there's nothing scalable about what we're doing. And that's actually the beauty and the value of what we're doing. And every relationship is important to us. Every member is important to us. There's so much value in the handwritten note and the personal thank you and the call and the individual lunch and those small group dinners. And over time, this value compounds. And we should proudly say there's nothing scalable about what we're doing. But that is ultimately the secret sauce of building a network.
- [21:46]
B
I remember when we went to the Berkshire meeting, I think it was Charlie Munger's last meeting with, with Warren Buffett to their annual meeting. And that that was an amazing experience that I'll always remember. What would you like our listeners to know about you? And how can listeners reach out if they're interested in learning. Learning more about 3i?
- [22:03]
A
Well, first of all, thank you, David, for having me on. 3 I Is this incredible community of investors. And we're growing and we're adding exited tech entrepreneurs, real estate entrepreneurs, family offices, fund managers, people who are interested in deploying significant dollars into the private markets, networking with their peers, and ultimately just enriching their personal business and investing lives. And look, if you're a listener of this podcast and someone who's interested in the types of things we were talking about today, I'd be delighted to have a conversation with you. You can reach out to me personally to learn more. It's teddy@threeimembers.com and what is interesting and where we want to take the network is, you know, adding high quality membership. And I'd be delighted to chat with you if you're interested in learning more.
- [22:42]
B
Well, Teddy, I appreciate you jumping on the podcast. Look forward to sitting down soon.
- [22:47]
A
Thanks, David. Talk to you soon. Thank you.