Podcast Notes & Highlights: Raja Doddala, Churchill Asset Management, on 'The Neon Show' w Siddhartha Ahluwalia
8 July 2024. Link to podcast page (with transcript). Below are my thoughts on the podcast and snippets of what I found interesting from it .
Sajith Pai’s Notes
Good podcast to listen to for understanding how an elite LP or Limited Partner (who provides money for VC fund managers or General Partners, known as GPs to invest) thinks abt the venture asset class. Typically in such podcasts where VCs interview LPs (it is an interesting GTM hack for fundraising) the usual question is to ask what LPs look for in GPs. Here Siddhartha cleverly inverts the question and asks what VCs should look for in LPs and evaluate them by, as well as what those who provide money to Fund of Funds LPs should evaluate these LPs by. I thought these were great questions and you got a sense of what differentiates a great LP from an also ran. Essentially it is the ability to get access to a top decile or top quartile manager, and get meaningful allocation in them, as well as the ability to coinvest. There is, Doddala says, “a lot of dispersion between the performance of top quartile and bottom quartile. Not so much dispersion in private equity, but in venture.” and hence, only an LP who can get access to the top quartile venture funds will make meaningful returns.
There is lots lots of interesting content in the podcast for VC fund managers, incl extremely tactical stuff like how a VC should organise the data room + the key metrics they should keep ready (Doddala: “A lot of people don’t break net out, which is really annoying. That’s usually a bad sign when you have gross IRR and gross TVPI versus net.”), why they should not delay the first close too much etc. Doddala also covers how Churchill Asset Management evaluates and selects venture fund managers - a key criteria is whether the manager is able to get meaningful allocation in the startup - this he says is the biggest predictor of success for a preseed / seed venture fund. Overall a good podcast for VC fund managers to check out, and absorb.
Highlights from the Podcast
All content below as stated by Raja Doddala, and the copyright for the below content belongs to The Neon Show.
Top five fund of funds
Raja Doddala: In terms of size, probably VenCap. They’ve been around a long time. There’s one called Vintage Investment Partners out of Tel Aviv. And oh, I’m forgetting the large US one, Stepstone, is a large fund of funds. Sapphire Ventures has a sizable fund of funds. And then I’d put us (Churchill Asset Mgt) in the, you know, sort of a somewhat large AUM.
Emerging manager definition per Raja Doddala
Raja: We’ve sort of had a rule of thumb fund 3 to 4 is when trends start to emerge whether they’ve been good at sourcing and picking and helping companies, that you’re no longer emerging. That’s kind of our rule of thumb.
About Churchill Asset Management
Raja: Yeah, so Churchill has about $50 odd billion in assets under management. Venture is relatively new, so it’s not significant. We have about 35 managers in our book. And it’s fairly large in terms of relatively speaking in the fund-to-funds ecosystem, but growing. We’re allocating every year.
280 to 300, that’s PE firms and 35 or so venture firms they have invested in. 25 managers in preseed and seed ($25m - $125m), and another 8-10 in Series A-D multistage larger Sandhill Road type funds ($500m - 2b range).
Yet to take third party capital. We’re currently investing our own capital source of work for this strategy. The source of our capital is our nonprofit parent called TIAA. Founded a hundred years ago by Andrew Carnegie, dedicated to financial wellness of educators and healthcare professionals that work in nonprofits.
What LPs need to keep in mind when looking at the venture asset class
Raja: If you’re an LP allocating to venture as part of your overall asset base, I think the thing to remember, that’s different about venture from either even private equity is that there’s a lot of dispersion between the performance of top quartile and bottom quartile. Not so much dispersion in private equity, but in venture.
What an investor needs to keep in mind while selecting Fund of Funds Managers
Raja: So the most important thing to look for when you’re selecting a fund of funds manager as an LP say a family office, is does the potential FoF Manager have demonstrated access to top quartile / top decile managers consistently? And are they able to get the allocation, the amount of allocation that they would need to make their portfolio math work? And do they have access to co-investments alongside the funds?
So those are the three aspects that I would look for if I’m a family office. Do they have access to top firms? Are they able to get enough allocation and are they able to access co-investments?
What a VC needs to keep in mind while selecting LPs
Raja: Typically what’s been sort of touted as a desirable LP is two different things that VCs (should) look for. One, how sticky is that capital? You know, is their investment time horizon long enough? Because VC is a long asset class. Is that patient capital? And can we count on them as long as we’re, you know, I’m speaking from the perspective of a VC firm, as long as we’re performing according to sort of our promises, can we count on that LP capital long-term?
That’s, you know, that’s important. And then two, are they forward thinking enough because venture is investing in, you know, sort of, you know, new technologies. Sometimes there could be cycles, you know, technology cycles that, you know, go, may not go according to plan. There may be a vintage that may not be top quartile. Are they understanding / patient in, in understanding cycles? And then the other, you know, sort of lately, you know, there’s the other aspect of, are they helpful?
Just like founders look for how helpful the VCs are, are the LPs helpful? And the help from LPs could come in the form of, can they help introduce us to other LPs as I’m raising my new funds? Can, can I count on them for references?
How Churchill selects a manager
Raja: For seed and pre-seed, the way we think about it is anywhere from 5 to 15% of the fund size is sort of what we look for in terms of a check size, depending on our familiarity with the manager or experience with the manager and their track record. And for series A and B, that would, that would be a rather sizable, much larger than a check that we were writing in a seed and pre-seed manager.
We see 2-300 firms a year. And we’re very selective. So call it, you know, 8 to 10% of the funds that we see, we commit. We have a fairly, I sort of call it an open book test. We don’t want to make it, we don’t want to make it an opaque sort of black box kind of a process. We have a sort of well-documented questions that we look for answers to. We openly share that with our managers.
And you know, usually if your data room is well-organized, we’re able to get most of it from the data room. And then we also, you know, check a lot of references. We want to see what your reputation is in the market, both from collaborating with other firms, but also what the experience will be for a founder to work with you. And if your data room does not have all the information then we’ll, you know, we’ll get on the phone with you. And then we typically spend a lot of time with you in person. We’re one of those people that are somewhat old school.
We like to see you where you work and your team and the team dynamic. And we really get to know you as people, especially seed and pre-seed managers you’re underwriting as much as the track record, but also you as people. We’re forecasting how you’ll behave for the next 10 to, you know, a lot of cases, 20 plus years.
And we’re forecasting how, you know, what kind of decisions that you’ll make. We’re forecasting how you evolve as a person because when we bet, when we bet on you, that fund will take 10 to 12 years for it to come back and then another vintage. So we’re talking about a multi-decade relationship.
So when you’re getting almost like getting married with a person for multi-decades, we want to spend time with you in person and get to know you. And what we say to our managers is that we set expectations very clearly. We sort of, you know, we’re a small team, even though it’s a large AUM, we’re not a large team, the underwriting team, especially.
So we clearly communicate, we sort of have a monthly investment committee meeting and we will tell you whether you’re proceeding to an investment committee process or not. When that happens, it’s typically a three to six week process, more, you know, closer to three than six. Then we’ll tell you when we start that process. And then at the end of that process, we’ll tell you our decision.
If it’s not a fit, we’ll tell you immediately. We’re able to rule out strategy fit and size fit and sector fit very quickly. If we didn’t rule you out in the first or second meeting, then yeah, typically a two to three month process.
Churchill’s venture portfolio
Raja: Typically, fund ones and fund twos are rare, but they do happen. But lots of fund threes, fours and fives.
We think, you know, especially seed and pre-seed is sort of a boutique business and we don’t think it should scale to hundreds of millions of dollars. So if you end up one of those people that would do that, we typically would opt out.
We’re in the US so, so, so we’re about 90% US, 10% Israel. And in the US predominantly probably 70% California, even in California out of the 70% that we have in California, probably 70% in the Bay area and maybe 30% in LA, an increasingly growing ecosystem. And then New York is probably 20 to 25%. And again, a growing ecosystem and then a handful that are in different cities.
So we tend not to be sector focused, especially, you know, seed and pre-seed, we think you’re, you’re betting more on the founder.
What metrics Churchill looks for in a GP
Raja: What we don’t do is we don’t invest in managers in fund one if they had no investing experience whatsoever. If this is the first time they’re writing a check that would never even pass the first email through us. For a first fund, what we’d look for is typically people had had a long angel track record writing small checks into companies. And in a lot of cases, more cases than not these are, you know, folks that had worked at other firms have a track record from those firms that are attributable to them. [Spinouts] It just so happens that they’re branching out and starting their own firms. So that’s always useful. So without either one of those, we wouldn’t invest in a first time fund.
Now, if you’re a fund two, even though it hasn’t completely been resolved, you still have fund one. We can see how, what kind of companies that you underwrote, and we can see graduation rates, which are really important. If you’re a seed manager, you know, what’s been the graduation rate to series A?
If you’re a pre-seed manager, what’s been the graduation rate to seed? And who’s in those syndicates? Who’s marking you up? And are they quality investors? And what are the business metrics of underlying companies? Have they been progressing at a pace that’s reasonable?
And those are different ways you can underwrite without a three to four fund track record. And in terms of funds with established track record, let’s say you are fund three, fund four, now you’ve had a few years, maybe a decade, 12, 13 years, then the classic metrics that we care about, there’s not one that’s more important than the other. So the three things that we look at is the IRR, DPI and TVPI.
You know, IRR is important in that the purpose of the IRR is if you’re an asset manager that’s allocating to multiple assets, then you have expectations for what the IRR is. IRR is a great way to compare one portfolio to the other, one asset class to the other. Are you getting enough of a premium commensurate with the risk? That’s the function of the IRR. And also the time period.
The other metric that we classically care about is DPI, sort of cash on cash. So typically 2.8 to 3 puts you in the top quartile depending on the vintage. And some vintages it may not. Some vintages it may put you in the top decile. So that’s important. DPI is important. But also if you took 15 to 20 years to produce 3X, then that IRR is probably 8% or 10%.
So you have to look at both. And then if you haven’t had any exits yet and there’s not a lot of liquidity, then the TVPI. So this is the unrealized, both realized and unrealized. And we also look at the quality of those markups if they’re unrealized. Are they paper marked? For example, I think 60% of the unicorns that were marked up in 2021-2022 are probably not going to ever realize their markups.
What is the underlying asset that has produced real DPI across their portfolio?
Raja: Enterprise is probably the most likely in terms of distribution. If you look at a normal distribution, the enterprise is probably the chunkier part of the distribution. And outliers probably have been consumer, but those are really rare. If you normalize it for the entire population, outcome per exit will be really, really small in the consumer. But the ones that do produce tend to be outliers.
So we tend to favor enterprise because I looked at some data, the exit data for the last 25 or 30 years. Median outcome is about 90 million, believe it or not. Obviously, there’s outliers, top, there’s like 20, 30 billion. But median outcome is about 90 million, 80 to 300 is the most likely outcome, and those tend to be enterprise companies.
Portfolio Construction Math across their portfolio
Raja: The most common we see is sort of 20 to 30 companies, maybe 40, and 30 to 40% reserves follow-ons for pro rata. [later clarifies “Yeah, 25 to 40 is the most common size we see”.]
What differentiates the top preseed / seed funds from the rest?
Raja: I think it’s the age-old question. But at the end of the day, what is your unique, I don’t want to be corny, but what is your superpower? Are you someone who’s well-respected? Most of the great pre-seed and seed companies in that area, are they going to come to you? And are they going to accept sort of your check where your contribution is not just capital, it’s something that you add to the table? And are you going to get meaningful ownership? That seems to be the biggest predictor.
And the second is, when you’re a pre-seed and seed manager, are you resilient? Do you have the patience to stick with that company for 10 to 12, sometimes 15 years? Are you able to... It’s a really hard work, and it’s a long process. And do you have the patience and do you have the wherewithal to help them?
And third is, are you able to get them to graduation? Are you able to introduce them to quality series A lead? And then maybe introduce them to some customers early on. So those are the sort of leading indicators of what makes a seed manager great. And we look for those, and they’re somewhat qualitative. But what we’d like to do is we’d like to be right more times than not.
Fund graduation rates
Raja: I’ve been hearing anecdotally, I don’t have the data in front of me, but the graduation rate from fund one to fund two apparently is at its lowest. I’ve seen some anecdotal data online that the mortality rate from fund one to fund two is like, I think we went from 7,000 or so active, I forget the number, is it 3,000 or 7,000 active funds to more like 1,500. So that tells me that a lot of funds either have decided not to raise their next fund or they are unable to raise.
And fund two to four is even lowest, which I think is healthy. I think we’re normalizing back to sort of normal. As an allocator to VC we think that this is a great time to allocate because of sort of more reasonableness in terms of process and timelines and fund sizes.
Raja’s advice for fund managers / GPs
Raja: I think the only thing I would say is be reasonable in terms of fund size. You got to decide what is your minimum viable fund size is, meaning what is the minimum amount of capital that you need to get reasonable amount of ownership in quality companies and the number of companies that you think you need. If that’s 15, depending on your strategy, 20 companies, whatever. And if you think it’s 50, maybe think lower. The lower the fund size, especially in this environment, the lower the fund size, the more the optionality is in the fund to create a 3-4X outcome and take your time deploying that capital.
And also expect to spend, I’d be hearing anywhere from nine to 12 months fundraising. But knowing that it’s going to take that long, what I would do is get to your first close as quickly as you can. And don’t wait until you get to a big number for the first close. If you’re raising a $30 million fund and if you have a line of sight to the $10 million, have a first close, start writing some checks so that the LPs that are still evaluating you can get a sense of the kind of companies that you’re able to access and the kind of ownership that you’re able to get. It’s easier to show them than tell them what your strategy is.
What is a good data room?
Raja: A good data room, depending on how many funds you have, will have clear... First thing that we look for when we get invited into a data room or we get introduced to a manager, what are the top line return numbers? Your IRR, your number of companies, the fund size, vintage, number of companies in the fund, current realized, non-realized value, net of fees.
A lot of people don’t break net out, which is really annoying. That’s usually a bad sign when you have gross IRR and gross TVPI versus net. Make it very, very easy to find those. Because a lot of LPs, especially LPs like us, we’re trying to target top quartile funds. If you have a track record, then if we’re not able to determine whether you’re top quartile or not, or it’s very difficult to get that from your data room, then your first contact with an LP is an unpleasant one. So I would make sure you have that.
And then once you pass through that gate, what we like to see is the quality of the portfolios. That means what are the companies underneath in the portfolio and how are they doing, their financials? Are they making progress? What are the customer concentrations? And then pipeline of your businesses. And if they’re close to profitability, what is the runway to profitability?
And who are in the syndicates? Who are the co-investors? And who are the references?
It’s not rocket science, but I think the easier you make it to find this information, the quicker and easier your underwriting process will be.
The most common mistake that preseed funds do, and one, the most one of my pet peeves is make it really hard to find your top line performance where we have to put it in Excel and calculate it. That would really create a bad impression. And gross versus net. Gross is meaningless to LPs. You have to have net of fees. And also, what are your fund drivers?
A lot of times it’s not obvious. You have 25 companies in a fund. What are the five or 10 that are really driving your markup, your IRR, your TVPI? Make it super easy to find that. A lot of times they make it really hard to find that.
Churchill’s India strategy
Raja: Yeah, so the way we think about geographies is we like to really do the work, show up on the ground, understand the ecosystem, understand the managers, and understand the syndicates, and exit environment, and the founder quality So there’s a lot of things that we sort of need to understand before we go into a market. We haven’t done that work in India yet. But India, obviously, it’s near to my heart.
It’s a place of my birth. And India is ascendant. On a world stage, tech has always been a strength of India. But we definitely need to show up and get to know people and get to know the ecosystem before we invest. Usually takes about a year for us to get to know an ecosystem. So we hope to do that work soon.
And I think one thing that I’m trying to learn about India is the liquidity. The story, again, this is probably an unfair story, because it’s sort of very anecdotal, is lots of great companies, liquidity has been slower in the Indian ecosystem. I think that’s in the process of changing.
I think we’ll probably start with a couple of managers, and then we’ll, you know, we’ll get to know the ecosystem, and then we’ll gradually increase that. That’s kind of, you know, based on how it’s going, you know, in other geographies that we entered, that’s kind of how it will go.
Churchill’s Israel experience
Raja: Yeah, we sort of stuck to smaller fund sizes, and we sort of, we had both. We have seed and sort of series A. So it’s pre-seed through series A is kind of what we did. We have four (managers).