Episode #447: Dave Thornton, Vested – Could Index Investing Come to Venture Capital?
Guest: Dave Thornton is a co-founder & Chief Customer Officer of Vested, which helps startup employees unlock the value in their equity.
Date Recorded: 8/31/2022 | Run-Time: 59:40
Summary: In today’s episode, Dave shares how Vested is providing liquidity for startup employees, along with a way for investors to access the beta of venture capital unlike it’s ever been done before. He shares the ins and outs of their business, the value-add they provide to startup employees about how to handle their stock options, and how they’re able to give people like yourself broad exposure to venture capital as an asset class.
Comments or suggestions? Interested in sponsoring an episode? Email us [email protected]
Links from the Episode:
- 1:36 – Intro
- 2:11 – Welcome to our guest, Dave Thornton
- 3:26 – An overview of Vested
- 8:18 – What separates Vested from existing options
- 24:14 – How Vested connects with employees and companies
- 27:35 – The reception of their offer from employees leaving early-stage startups
- 30:24 – Balancing supply and demand to get the company off the ground
- 32:10 – What people should be thinking about as they leave early-stage startups
- 35:26 – Insights and takeaways from working in this space the last 3-4 years
- 40:02 – Episode #122: Phil Haslett, EquityZen; The growing interest in secondary markets
- 44:40 – Lessons learned over the past couple of years building Vested
- 47:42 – Can there be a VC index?
- 49:32 – Trillions, Robin Wigglesworth
- 51:19 – What’s next for Dave as he looks out to the horizon
- 54:22 – Dave’s most memorable investment
- 55:49 – Learn more about Dave; vested.co; [email protected]; [email protected]
- Learn more about Vested:
- vested.co – if you’re an employee who needs help with their startup equity
- vested.co/investor – if you want to learn about how they invest
- [email protected] – email their Head of Capital Markets if you want to learn more about Vested
Transcript
Welcome Message: Welcome to “The Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Sponsor Message: Today’s episode is sponsored by The Idea Farm, my own private curated research service that gives investors access to research reports often used by the world’s largest institutions, funds, and money managers. These reports come from some of the most respected shops and investing, many of them costing thousands of dollars.
We also send our favorite investing podcasts from the past week, so you can be sure to only listen to the best of the best. Also include in the subscription, we send out our quarterly valuation updates like the CAPE ratio so you can see which countries appear to be the cheapest for new investment dollars in the stock markets all around the world.
We also have the quant backtester which allows you to evaluate very strategic and asset allocation strategies going back in time. So, all this can be yours with the subscription of The Idea Farm, and best of all, you can try it out at for a free, no-risk 30-day trial. Are you ready for an investing edge? Visit theideafarm.com to learn more
Meb: What’s up, my friends? Really fun show today. Our guest is Dave Thornton, co-founder and chief customer officer of Vested, which helps startup employees unlock the value in their equity. In today’s episode, Dave shares how Vested is providing liquidity for startup employees along with a way for investors to access the beta of venture capital unlike it’s ever been done before.
He shares the ins and outs of their business, the value they provide to startup employees about how to handle their stock options and how they’re able to give people like yourself broad exposure to venture capital as an asset class. Please enjoy this episode with Vested’s, Dave Thornton.
Meb: Dave, welcome to the show.
Dave: Thank you, Meb. Glad to be here. Thanks for having me.
Meb: What is up, man? Where are you? Where do we find you today?
Dave: Today you find me in Weston, Florida, which is Fort Lauderdale latitude and like, 20 miles inland.
Meb: Are you a Florida man by birth originally, is that where you’re from always?
Dave: I am from Miami originally. I spent most of my adult life in Manhattan. And then when we had kids that were old enough to need grandparents around all the time, we came back down to South Florida.
Meb: Was the COVID/just general migration, does Weston feel that too, or not so much?
Dave: Yeah. This is one of the two markets that I’ve accidentally timed really, really well. I left New York in 2016 and got here well before COVID, bought a few years, and then my neck of the woods just got slammed with demand.
Meb: Last time you saw alligator in the wild?
Dave: A little over a year ago, but not in the Everglades, which I am right next to. It was in the central water fixture in our development. My kids’ side, I mean, they saw just the eyes out of the water.
Meb: Yeah. A lot of critters down there. Very cool spot. All right. So, we’re going to talk about a lot of stuff today, but you guys have a pretty unique and interesting company you have going on. The discussion of the company will obviously morph into discussion of the space in general, but let’s start with what is Vested.
Dave: So, from an investment professional’s perspective, Vested is an easy way to access VC. And I think having said that I need to give a whole bunch of context, and we’ll eventually get around to how the business itself operates. But I saw an article not too long ago, like June from RA Intel that said something to the effect of 83% of advisors think that even retail investors should have access to alternatives.
And I’ve put that up against my working knowledge of the RA world and the high net worth world. And I don’t know what you would guess, but I would guess that the percentage of folks that could access alternatives that actually access alternatives is well below half of that. Actually, do you have a guess?
Meb: I have better than a guess because my favorite thing to do in the world is to do polls on Twitter. Usually, it’s like a historical fact that I’m trying to, you know, demonstrate a lesson on. So, for example, you know, we say what’s the biggest after-inflation loss on T-bills, and most people think it’s like 0% to 10%. The answer’s over 50. Right? Like these type of polls, just to educate.
But we did one where we asked investors, we said, “Do you invest in all these different categories?” And I did about 20. And the answer’s always the same, but I just kind of was curious, you know, “Do you own U.S. stocks?” Ninety percent said yes. “Do you own XUS stocks?” Eighty percent all the way down. A minority owns real estate or real assets, excluding their house. So, not many people do.
And then you start to get into the periphery, and this isn’t just pros. You kind of have to be either professional or professional leaning to follow my boring tweets. So, “Do you invest in private equity?” Eighty-five percent no. “Do you invest in…” I thought I did VC. I did startup, so 82% no, but on and on. So, but also 84% says don’t have a financial advisor. So, this audience is a little different than… But I think it’s most don’t.
Dave: I was going to guess something closer to 90% don’t invest in VC, which is close to the 82% that you just gave, or the startups part that you just gave. So, we know that you need alternatives in your portfolio and it’s not like people don’t want to be in VC. Like, everybody knows VC should be one major sleeve of your alternatives portfolio. It’s just that nobody seems to actually have affected their way into VC.
So, the access part is hard for a number of reasons. One is the volatility associated with the ways in which you can invest in VC. You can try to put your money into an individual company, and that’s either a 0 or a 10 to a 100. And that’s a huge amount of variance for most people. You can put your money into a single VC manager if they’ll take your call. And then that gets you like 10 to 15 shots on goal, but in any particular vintage for any particular manager, that can also be anywhere from like -50% to +5X.
And if you wanted to put your money into, like, I don’t know, a Blue Chip VC fund whose name everybody knows like Andreessen Horowitz, they mostly won’t take your call unless you’ve got 10 million bucks to put in. Like, I’m actually a perfect case study for this. So, I have enough discretionary investible capital that I could be in VC, but if I called up a16z and said like, “Hi, my name’s Dave Thornton, I’ve got a 250-grand check for your next fund,” they would probably laugh and hang up on me.
So, it’s not the easiest thing to actually take the desire to be in VC and to execute on it. So, Vested, our fund product is something that takes as much of the friction out as possible. And I mean that in kind of two ways. So, number one, it is a single ticket into the entire asset class. The nature and the composition of the fund is it’s got a lot of little positions across stages, and sectors, and founding years.
And so, like, you don’t need to do VC manager selection and manage 5k ones, it’s just one ticket, and then you’re going to get, you know, a single report and you’re done. The other part of the ease of access is, like, the sleep at night factor, which is it’s really an index fund more than anything else. Like you’re not going to take a huge roller coaster. Our last fund had 196 companies in it. And I’m sure that half of them will be zeros, but that’s like built into the design.
The point is you’re not going to go up and down and up and down with the trials and tribulations of individual companies. So, that’s Vested from an investment professional’s perspective. It’s just easy single-ticket access to VC.
Meb: Okay. Some people listening probably say, okay… And just to distinguished, listeners, and sure, we talk enough about this on the show, but distinguishing between venture capital, which is what you guys are focused on, right, and private equity as a general asset class, private equity usually, even though it describes both, is usually referring specifically in the jargon, in my mind, to leverage buyouts and late-stage, you know, companies, whether either they’re public and going private or, you know, 20 billion-plus, usually even higher in my mind.
Whereas VC is often the seed through Series A, B, C, D companies from anything from $5 million market cap up to, is there a max you guys look at? Is it into the billions?
Dave: There’s no real max as long as it’s still private. And as I’m sure you’re aware and your listeners are aware too, the trend in the last 15, 20 years is for companies to stay private progressively longer, and longer, and longer. So, you’re seeing companies that are worth $20 billion as of their last funding ground and they’re still private, and that’s okay. So, like, we’ll take Series H companies, and I’ll be specific about like when we take them, but anything that is pre-IPO all the way starting at seed.
Meb: So, imagine listeners are saying, “Okay, Meb, Dave, nothing new here. Like, doesn’t this exist already? Can’t I buy into kind of a low minimum feeder fund for VC or VC fund to funds? Like, why is this different idea?”
Dave: For a regular VC fund, you’re going to have 10 or 15 positions. And so the amount of fluctuation in returns is pretty high, and that may not be that comfortable for you, especially if that’s your one bullet for VC. For a fund of funds, the fund of funds that I’m aware of are not so available right now. They’re not all over the place and easy to get to, but we also compare very favorably against a fund of funds in a number of dimensions.
So, number one, a fund of funds inherently has multiple layers of fee whereas we don’t. Number two, on a look-through basis, fund of funds are way more concentrated than we are because like every VC manager in a given fund of funds is probably going to be in strike. And so, although any one of them may not have a lot of concentration in their portfolio, the overall fund of funds concentration is pretty high.
Number three, we have a lot more at-bats. If this fund that we end up raising that we’re doing right now, which is our third fund ends up covering, call it like 100 million in assets, we’re going to have 1000 positions in it. Whereas a fund of funds is not going to have more than 100 or 150. And the at-bats piece really matters in VC because of the power loss. So, you’ve got companies that are often going to 0 and occasionally going to 100, and you just need to have as many opportunities to grab 100 extras as possible.
Meb: You know, we talked about this before, but I think that is a well understood… I mean, it’s not a new concept. Everyone talks about power laws, they get it, but it’s such a critical insight that I don’t think people actually act on enough. And your example is, like, “Look, if you’re allocating to a VC fund, you have 10 shots.” That’s not enough. I don’t even think 50 shots is enough.
And I said… I did a blog post last year where we were talking about kind of my angel investing journey, and I’m up to like 350 or something now. And I don’t even know if 100 necessarily, like if you get the timing wrong, you miss just a few. And I look at the composition of my portfolio, the vast majority is driven by just a handful of names, you know.
So to me, it’s like more breadth is better. There’s always a phrase like the diversification or concepts like that, where…spray and prey. That’s the one. It sounds derogatory, but when people say that about me, I say, “Thank you. That’s a compliment.” When it comes to VC
Dave: In VC, and in particular the early stages where like so much of the big growth on the winners is, like spray and prey is a much better approach. And this has actually been studied. AngelLists Quant Fund has put out a paper on this where it’s like late-stage, be very judicious. You want to make sure you’re not buying into the wrong price. These companies have another 2X left in them, but early-stage, it’s absolutely the right thing to do to take an index-like approach for exactly this reason.
Meb: Yeah. Okay. So, can you talk about the terms of, like, so an investor, you said it’s easier? All right. So I click, I send you guys a million bucks from my clients, do I do it through like a custodian Schwab, Fidelity? Or is it like if I’m an individual, do I just send it directly to Dave at your house address in Florida? What’s the terms? When can I get my money out? How does it work?
Dave: An individual can invest directly, but because we know that the RA channel is full of the folks that are going to find our product offering most attractive, we’ve gone through the effort to be institutionally diligence. We’re now on TD Ameritrade, and Schwab, and Fidelity, and Pershing. So, I would say like 90% of the RA world is probably covered and doesn’t need to write their checks in a held-away basis.
The timing of the fund is a five-year fund plus one plus one. So, it’s a little bit shorter than your average VC fund. And most of that is because RAs are making financial plans on behalf of their clients. And most people don’t make 10-year financial plans or 12-year financial plans. They make five-year financial plans.
Meb: Can you explain the plus one plus one?
Dave: Yeah. The idea is that if at the end of five years there are, I don’t know, a couple positions, that it would be better to wait on for liquidity than to sell at a slight discount and return everybody’s capital. We will optionally extend the life of the fund by one year and maybe by one more year. So, it’s intended to be private-owned.
Meb: If somebody’s like, “Oh crap, man, year three, I got to move. I got divorced. Whatever. I need my money back.” Is it just like kind of tough darts? What do you do?
Dave: So, the short answer is, yes, it’s going to be a five-year lockup, but the real answer is not exactly. So, we’re going to be putting on so many positions that many of them will have had their liquidity events well before the five-year mark. And our intention is to batch up those gains and distribute them as they come in. So, we should have very clear cash flow properties once deployment is done starting in year one.
Meb: So here we are. So, imagine everyone’s like, “Okay. Meb, sort of interesting, but hold on a second. You mentioned you own a lot of positions. How in God’s name do you guys get access? How are you able to invest in that many positions? Do you have a secret back door to Sandhill road? Like, does this work? How can you guys acquire so much stock? What’s the means that happens?”
Dave: Yeah. The short answer is, yes, we do have a secret back door. Our secret back door is through the employees of startups. So, there’s this incredible and large problem that startup employees end up having that most people don’t know about unless they’ve lived through it. The general idea is that you’re a startup employee, most of your comp is in stock, less in cash because startups tend to have less cash.
And that stock bests over time and it is usually in the form of stock options, meaning it’s the option to buy a share, not actually the share itself. So, the gruesome thing that happens at the end of most folks’ tenure at a startup is they realize, for the first time, when they get an email from HR, as they’re on their way out, it’s like, “Here, send us your laptop, and also, you have 90 days to exercise your Vested stock options.”
And if they don’t find the money to do that, the underlying shares go back into the corporate treasury and all of the primary form of their comp for the last three years just goes up in smoke. So, what we do is we help employees who are departing come up with the money to fund their option exercise. Typically what we’re doing is we’re just purchasing a subset of the shares that they’re exercising their way into in exchange for all of the money necessary for them to affect the entire exercise and also inclusive of their tax obligations on top of the exercise.
So, we have built this huge machine that starts off by taking a look at the 30,000 companies in the U.S. headquartered part of the VC asset class. We knock out about 20,000 companies on the basis of financing trajectory that’s a little bit wishy-washy. So, for example, we’re not looking at companies that have recently had a down round or recently had any massive investor attrition, then we send the remaining roughly 10,000 companies into a system that we’ve built on top of job sites.
And the system on top of the job sites is looking for the employees that have just left these companies and are going to be in that 90-day window of pretty acute distress. So, we will reach out to them in an automated way through a combination of email and LinkedIn. And for the folks that do find themselves in this position, we’ll direct them to our website.
Our website has a whole bunch of tools that are pretty cool, but interestingly, for this group, it has a transactional flow that is part explainer. Like, what is it that we’re all doing here? What’s an exercise? How much money are you going to need? And part deal structuring tool where at the end of it, they get all the way down and they submit an options funding request. And that’s the way in which we acquire stock from many, many different companies across many different employees, you know, little bite by little bite.
Meb: Yeah. This is where the light bulb kind of went off for me and first time I heard about you guys. I always love, like, an interesting and unique wedge, particularly one that comes with something that is what I call, like, a frustration arbitrage where, like, no one’s really incentivized to do what you guys were doing, particularly at scale until you guys did it. So, company’s, like, “Whatever, man, you’re out of here. We don’t care if you… I mean, we’re probably better off if you don’t exercise this.”
And then on the other side is like, how is that even something you can contact? Like, all these things. So, this is why I was like, “Oh, this is such a cool idea.” When you had the origin story, this idea, so let’s call it what, three years ago, four years ago, what was the inspiration for this? Did you go through a similar situation or have somebody, you know, or what caused you to come up with this kind of hare brain wonderful idea?
Dave: So, first of all, every principal at Vested has some version of this. My version of it was my old company. I was the founder and the CEO, and when it got acquired, it was a half-cash, half-stock deal where everybody had the opportunity to take different percentages of their payout in stock. And I gave genuinely bad advice to one of my engineers.
So, Andy Nelson, if you’re listening to this, I’m really sorry. Although I know it worked out for you in the end, but I still live with the guilt. I told him that the mechanical stock option exercise that he would do that was in the middle of the acquisition transaction would end up being tax-free because he was going to then trade stock for stock and it would be fine. And he ended up with a $15,000 tax bill that he had to go out of pocket on that year.
And it was a wake-up moment for me because I worked at a hedge fund. I went to law school, I’m a reasonably sophisticated person. And I was like, “Man, if I can screw up stock option exercise and the advice around that, I’m sure anybody can.” It is complicated. And segue for another time is like, I don’t think you should owe taxes on the paper game associated with your stock option exercise because it’s still paper.
Meb: Right. Yeah. It’s weird. And on top of that, you know, look, I mean, most individuals aren’t necessarily experts on personal finance and things of this nature. Like, particularly at companies and tech companies and either non-tech companies, you could have a retail startup and expecting not just the employees to know, but even upper sea level management.
I had moan all the time jokingly about things as simple as like filing my taxes each year where we were talking about on Twitter the other day, I was like, you know, like the old Rumsfeld letter, I was like, “I can guarantee with certainty that I did this to my best of ability and 100% chance, like, there’s something wrong.” Like, it’s just so complicated. And I’m a professional, like, I should know how to do this.
So, you kind of went through this and then you were like, “Huh, I wonder if this can be like an actual offering.” What gave you sort of like the audacious belief that you could kind of nuzzle into this as an actual entire company as opposed to just like a way for companies to do this slightly better?
Dave: It actually happened organically. So, when Vested started, the two problems that it was trying to solve for startup employees who needed more help and more support than they were currently getting were the problems of knowledge and capital. So what is this stock thing that I just got, and how does it work? And then how do I do something with it when I need cash to do something with it?
So, we started actually with the knowledge side, and we had these tools. We have an equity fairness calculator that helps you figure out whether your equity comp is market. We’ve got an outcome simulator that helps you dream really big and imagine what your piece will be worth if your company IPO is for a billion dollars. We’ve got equity management tools so that we can just kind of keep you up with the relative value of your equity over time.
And out of the bottom of that database, started to appear people that needed transactional help the way that I was describing before, which is like they just left their job and they need money to exercise their options. So, we started talking to all of these people that needed help and the folks ended up being very bi-modally distributed. So, there’s only two categories of people that we saw.
One was people that were leaving Palantir and needed a million dollars to make sure that their huge payday on the IPO didn’t blow up. And those people were just talking to us to kick tires. Like, there is a couple other options funding shops out there in the world and there was a feeding frenzy over financing these Palantir option exercises. And then there was the other category of people, which was, you know, the guy that just left his first job at a Series C startup and he needed 40 grand.
And that set of folks were so happy to talk to us. They were so happy that we would give them the time of day. The bank already told them that they can’t collateralize against private shares. They already thought about going to their parents and realize it’s a pretty bad look to ask your parents to effectively invest in the company that you just left.
And so we realized like there’s probably 98% of these startup employee market lives in that category and nobody’s paying attention to them. And the primary reason that nobody’s paying attention to them is because as an outside investor, it’s just really difficult to diligence with publicly available information in earlier or a mid-stage startup. It’s not difficult to diligence a late-stage startup, but it takes a lot of work, and you don’t want to write like a 70-grand ticket at the end of all the work that you just did.
So, like, the people that needed a little bit of money and the people that were leaving early and mid-stage startups were just completely unnerved. So that was the organic recognition that there was a clear problem here. And then we started thinking to ourselves like, “How do we access this? Like, we don’t know who the winners are in VC. We’re outside investors too. And especially on the earlier stages, we can’t diligence these folks as well as we’d like either.”
And we started doing a bunch of analyses about what common stock, which is what employees tend to hold or have the option to buy is actually worth. And we realize that if we buy a whole bunch of common stock, if we do a little bit of trimming around the edges and we avoid the biggest dumpster fires, like get rid of that 20,000 companies from the 30,000 companies that I described earlier and we buy the rest of the asset class pretty cheap and in a very diversified and unconcentrated way, we’re basically tracking the median return of the VC asset class juiced by a discount that we’re buying, and that could be a great financial product.
So, having had the idea for the financial product, we then said about looking for, like, who are the buyers of this product. It’s not the people that can already get into Andrews and Horowitz. It’s the folks that know they need to get into VC and don’t have the easiest way. And even if they did have an easy way, it’s not particularly risk-adjusted, so it wouldn’t be that comfortable. So, that struck us as the high net worths and the RAs who manage their money.
Meb: This is the second part that kind of struck a nerve for me or funny bone, because I’m a cheap bastard anytime I hear the word discount. I was tweeting the other day. I said, you know, there’s so many of these online marketplaces. And I was joking. I think I CCed my buddy, Corey Hoffstein. I was like, “Corey, can you write some sort of algorithm that’ll like reach out to all of these and be like, “Hey, Meb is the bid like 30% to 50% below that if you just need liquidity, he’s like, he’ll take it. He’ll take all you got, the assets that you want to sell.”
But so you guys came up with this idea, and, you know, embedded in this transaction is essentially a fee for doing it, which talk about it being a discount. In the beginning, and walk us through now too, did you reach out to companies or did you reach out directly to the employees? Because my thinking is, I was like, “Hey, will companies be happy or annoyed about it?” And I don’t know what the answer is.
But, B, it seems to me, if I was a company doing this, I would want it as almost like an employee benefit. Be like, “By the way, here you go. We want you to be happy.” What was the vibe as you kind of started to roll out this idea?
Dave: Yeah. To start at the end, I do think that the smartest companies are going to end up doing this as an employee benefit.
Meb: With you though, right?
Dave: With us. I mean, they should do it period to keep their folks. If they’d like to do it with us, we will be there for them. And that would be awesome. And I do think that’s the end state of this market.
Meb: Well, because it gives them like a third party. Like, I don’t know why they would want to do it internally. Anytime you can outsource your, like, risk of these sort of arms-length sort of things, like, I don’t know why you wouldn’t want to, but okay. Keep going.
Dave: It’s a perfect product for a third party to do for the company so that they can have a recruiting and a retention tool. So, I agree with that. So, what do we do right now? Right now, we go directly to the employees. And usually what we’re doing is we’re forward-purchasing a subset of their shares, meaning we give them the money now, but they don’t actually deliver us the shares until later after there’s a liquidity event of some sort that either lapses or nullifies the transfer restrictions on those shares.
Originally, we went to the companies after we did our first handful of transactions and we said, “Hey, it would make us feel pretty comfortable on delivery risk if you guys would maybe put these shares into escrow or retitle them or something like that.” And across the board, the companies were like, “Listen, it’s a $72,000 transaction, so we don’t care. It’s an ex-employee, so we don’t need to worry about disincentivization risk if they sell a subset of their shares.
And if you tell us that you just priced our shares either explicitly or implicitly, we might have a duty to spin up an independent valuation provider to come back in and redo what’s called our 409A valuation, and that’s going to distract our legal inequity team for like two weeks. So, like, please go ahead and do what you’re doing. As long as you’re doing it at the bite-size and at the scale that you’re doing, you’re not pushing like $10 million of our companies stock through, like, do it directly with the employees,” was the feedback that we got.
So, probably three, four years from now when we are much bigger and we’re deploying, you know, $2 billion a year as opposed to less, then we’ll probably want to work directly with the companies because they’re probably going to want to control the transactions. But at the scale that we currently operate at with small bite sizes and no more than, for example, 250 grand going into any particular company, it’s actually much better for everybody to do it directly with the employee.
Meb: All right. So, you guys start this experiment in the early days, start reaching out. I’m saying once you get to a conversation, you get an employee that’s leaving and you say, “Hey, can you finance this? If you need help, hit us up.” Like, how often are they receptive to that? Or, you know, is it something that’s actually, like, a majority of the time, a huge minority of the time? I’m just wondering. And prior, I wonder how many were just like, “Dude, I don’t have the money for this. I don’t even want to deal with it. I don’t care. I hate these guys. I’m moving on.”
Dave: That’s actually the reason that we built the machinery, the outreach machinery that I described, was that this particular set of ex-employees, the ones that were leaving early-stage startups and/or had really small ticket needs, they would quietly give up most of the time. And so we needed to go out to them and tell them that there was actually a solution for them and put it on their radar pretty explicitly.
The reception that we get is really good. I don’t have any other way to say it than that. We have a lot of people, we reach out to them on LinkedIn with kind of like, a generalized connection request, for example, to start, and we’ll mention that we’re kind of a startup employee’s best friend around their equity and they’ll be like, “Great timing. I actually have this problem right now. Can you help me?”
So, the reception’s pretty good, and I think it’s as good as it is because this was a totally unnerved need just to put numbers around the need because it really is like, it feels like an under the rock, like esoteric-type problem, but it’s huge. Call the total capitalization of the U.S. headquartered VC vet companies like, a few trillion dollars called $4 trillion, about 30% of that is owned by employees. And so that’s $1.2 trillion and no less than 50% of options go abandoned. So, that’s $600 billion in share bank.
Meb: That makes the old gift cards look quaint in comparison. You know, it’s like the percentage of Starbucks cards that they’re sitting on that never get used. Is that partially because the companies flame and go out of business and the options are just not worth something or is it just actually, it’s like, no, the ones that are…
Dave: You can haircut it a number of different ways. There’s no way to get down to a number that’s all of a sudden feeling small. So, like, some people haven’t stayed at their company long enough for their options to be well in the money. Some companies go out of business. Some folks didn’t have a big enough grant in order to, like, maybe they only had $2,000 within the money options and they just don’t care. But in any case, make it $400, or $300, or $200 and it’s still just a massive unsolved problem.
Meb: So, clearly there’s a lot of supply. Right? There’s a lot of people that probably want this, and you guys are doing this outreach and, you know, you’ve raised near now into fund three. So, whatever it is, tens, hundreds of millions of dollars, but in the early days, how did you balance the supply-demand?
Because, like, you’re reaching out to people, you want to make sure there’s enough, but then you’re like, “Oh, wait, we don’t have enough money, or we need to raise another fund.” How’d you figure that out? Or do you have like a huge credit line you can draw on? Like, how’s it work?
Dave: We are in love with the idea of putting together a huge credit line. We haven’t yet, but if we did that, that would kind of explode our business. At the beginning, we thought we might be supply-constrained, which was a little bit crazy in hindsight. We had our first scaled fund, which is our fund too, which is a $25 million fund. And we thought it would take us, I don’t know, somewhere between like six and nine months to deploy, and it took us less than four and a half.
Since then, we’ve been even more supply-constrained because in the current market, you’ve got a bunch of otherwise healthy VC vet companies that are doing 10% to 20% layoffs, which produces a massive amount of deal flow for us.
Meb: Yeah. You just go hit up all the snap crew now.
Dave: Yeah.
Meb: Was that the big news this week? I think Snap was like 20% of their workforce or something.
Dave: Yeah. Actually, I was a little bit blasé about some of the company selection criteria earlier on, because really, it is like, we’re trying to get rid of losers rather than pick winners and buy everything else cheap. But in the current environment, we’re paying quite a bit more attention to, like, employee turnover. The level of employee turnover, then nature, are the executives leaving or are they not? Where companies are trading in the secondary markets, when they’re trading, what the fair market value of common stock which moves once a year, but usually pretty quietly is doing.
So, we’ve actually gotten even more data-driven than we already are. And to your Snap point, and maybe, like, abeta.com is another example where their CEO famously fired a whole bunch of people over Zoom and they’ve had their spec push back and back. So, we’re not doing every deal, but in the current market, there are plenty of healthy companies that are just laying off 10% to 20%.
Meb: The funds you guys are raising, is it sort of open-ended and once you hit the cap, that’s it? Is that how it works?
Dave: We’re always going to be matching the AUM that comes into deals that are basically like at our doorstep. And so the real capacity constraint is like the 100 LP constraint on an unregistered fund that’s taking accreditors. So, as soon as we hit that cap, however many dollars are under management, that’s the size of the fund.
Meb: So, let’s say you’re talking to some of the people who are listening. We have a little bit of everything on this podcast, but let’s say I live in the Bay Area, I just got my notice, promising startup, but you know how it goes. What should people be thinking about in general? They talk to you guys, or if there’s other sources, what should they know as they leave? Anything in general that should be on their mind? Any ideas?
Dave: From an employee perspective’s, I think the most important thing to know is that there are financing options available. You may have to work a little bit hard to find them because the industry is in its nascency now relative to where it will be in five years, but, like, do not leave your unvested options on the table if you can find free money. Just don’t do it. That’s too big a portion of your compensation for the last few years. So fight tooth and nail to go find some money to make sure you can do your exercise.
There are a handful of folks that are out there in the world. So, like two partners of ours, for example, in the options funding space are Quid and SecFi, they tend to do the later-stage bigger deals that I was just mentioning. And we have referral relationships with them. Like, they’re not competitors. They really are partners. The smaller earlier-stage deals they send to us, the bigger later-stage deals we send to them. There are shops out there in the world that do this, and you just need to not give up when the bank says no.
Meb: Is any of these people should be mindful of as they either join a company or work there? Is it something we’re like okay… I mean, obviously, they get into the situation which obviously benefits you guys, but, like, they enter, they’re be like, “Okay, I need to start saving for this option exercise. I need to put it in a bucket, otherwise, you know, like, I’m not even thinking about it.”
Dave: It is a good idea if you can, especially the savings part. It’s usually not that beneficial to exercise your options before you need to unless one of two circumstances is the case. So, if your company is very early-stage and you can qualify for qualified small business status at the point that you exercise your options, that is one gift from the government that you might want to take a little bit of risk on it.
It relieves the first $10 million in taxes on gains when there is ultimately a liquidity event. So that might be one reason to think about exercising earlier rather than later. Another reason is if you are pretty sure there’s a liquidity event on the horizon and you need to exercise to start the capital gains clock ticking on your share ownership so that you can sell after a year, which hopefully will be, you know, contemporaneous with the liquidity event and benefit from long-term capital gains tax treatment as opposed to short-term capital gains.
Otherwise, you’re taking real risk to exercise early. So, I like the idea of putting money aside incrementally such that if you think you’re going to be at this job for an average of three years, which is what most startup employees stay for, you’re not caught completely flat-footed when you leave with that bill.
Meb: As you guys start to build this out, I mean, we can spend probably 20 minutes brainstorming now just on like what the future looks like, but let’s stay here for a minute. You started at sort of a period where markets were on the roller coaster up. Right? I feel like maybe in the early-stage world/a lot of, particularly the tech world, the peak maybe early ’21.
Man, the years are just peeling off at this point, but trying to subjectively pinpoint…well, the mood has been a little more doer in VC world, despite I still see a gazillion investments and deals happening, but VCs are an emotional bunch. What sort of insights or takeaways have you seen over the last, you know, 3, 4 years of working in this space? Any generalizations or other ideas?
Dave: So, I’ll say this. For me, the height of the market was probably October, November of last year, before the beginning of the denouements, before the absolute carnage of the last like six months. And when things started to go down in April, May, at least the stuff that I saw that was visible, it was mostly very late-stage companies following the public markets, the idea being that like, their next pricing event is a public markets pricing event, and as a result, like, there’s no way for them to keep their valuation artificially high and hope that there’s another VC in another round. I saw ripple effects go upstream, which is to say the latest stage companies took huge hits. And I mean, like Klarna as an example, and they raised a really big down round. Instacart has written themselves down.
Beta.com that I mentioned earlier, they had their spec just shelved. And I don’t think they’re doing quite as well as they were. But then you go all the way upstream, and I haven’t seen nearly as much effect on the earlier-stage companies, which kind of makes sense because they have their whole life ahead of them.
If they just raised in the last year or two, they probably raised at a bigger valuation and they raised more money than they needed, so they’re just going to tighten their belts and duration of exit will be extended a little bit, but they’ll probably be fine.
Meb: That’s the nice thing about, you know, we wrote about this is people started to dip their toe into the world of startup or VC investing. I said, you know, you got to think about your world as vintages. You allocate and you have to, in my mind, you want to allocate for ideally 10 years straight. So, you get the good times, the bad times. I mean, weird part about VC and grant.
This is just sentiment, so I don’t think it’s actually the way they actually behave, but you see it in the funding news and announcements that it’s so cyclical, right? Like, if I was a VC, I would love to just be the anti-cyclical VC where everyone’s pulling back and round valuations are going down. Like, that’s what I’m probably more interested. Recessions and…
Because you look at some of the best companies, Uber, Google, on and on, they were started during bear markets in U.S. stocks. And so you guys had any good winners? And, like, looking back on it, is there any correlation whatsoever to be like these go in the portfolio? You’re like, “Ah, sweet. I’m stoked we have this.” Or is it just like totally random?
Dave: So, there are some correlations that I’ve seen. And actually, the winner question is it’s a really interesting question because we’re not a typical VC in the sense that we don’t just have liquidity events when the company does well. Like, when the company sells or goes public. We have liquidity events anytime an employee gets paid, which includes, in addition to corporate level liquidity events, when they sell their shares in a tender offer, when they sell their shares on the secondary markets.
So we’ve got a couple of extra off ramps, and for the most part, we are the sharpers for our customers, the employees into the secondary markets, and we’re paying attention to the secondary markets when we can. And sometimes we’ll see a great bid over on the secondary market and we’ll tap our customer on the shoulder and say, “You should really walk down to Forge Global or EquityZen or Nasdaq PrivateMmarket and consider selling your shares because that’s a pretty wild price.”
That actually relates to which winners can we see coming. If names are trading on the secondary markets and we happen to have some visibility into that around the time that we’re putting on a position in the first place, it’s usually the case that it’ll be trading in three months or six months or maybe even a year later, at which point we can tell our customers about the great bid that lives down the street and kind of produce our own liquidity events.
Meb: Are those sort of the big three as far as secondary markets? You know, at secondary markets, it’s been an interesting space to observe over the past decade. You’ve seen them gain sun traction, but to me, it’s always seemed like they just haven’t had much depth in liquidity. Am I totally wrong on that? Because I don’t pay a lot of attention.
You know, for me, I remember chairs post. We’ve done a few podcasts on the topic with EquityZen and I’ve done a few investments there, but who are the big players there? And give me an overview of that space. Is it growing?
Dave: You are aggressively right on that. There is just a whole big world to unlock that hasn’t been unlocked yet. My view is that the primary buyers on the secondary markets are the folks that want to really know a lot about these companies. And as a result, they’re limited to the companies that there is a lot to know about.
So, like SpaceX and Stripe and like the latest-stage biggest name companies, probably only a few hundred names are trading on the secondary markets in a normal world and probably 100 in the last few months’ worth of, you know, market carnage and everybody pulling back. So, I think it’s the nature of the buyers on the secondary markets that is preventing them from really exploding.
And the names that we interact with a bunch are Forge Global, EquityZen, and Nasdaq Private Market. There are a whole bunch of other secondary market brokers that are less tech-enabled and less visible. Seta Capital is an example. And then there’s 10,000 people running around kind of connecting buyers to sellers on their own as individuals. And that part of the market is just going to continue to be opaque for a while.
But yeah, there’s trillions of dollars of notional out there and there’s billions of dollars that are actually trading on the secondary markets. And, you know, that’s a 1/1000th gap.
Meb: This is a good marketing idea for you. You need like the vested hall of fame. You can just put the company names where you guys had the biggest returns. I don’t think you’ll be allowed to, but would be cool if you could. It still seems like an opportunity. It’s strange to me that it hasn’t…these sort of marketplaces haven’t really developed into a very transparent and liquid marketplace. Does that feel strange to you or is it just like, too hard? Like, what’s the problem?
Dave: I think the thing that they’re not doing is expanding from the single-name opportunities. They’re not expanding from their current buyer base. So, like, the vested product is a product that could unlock those markets pretty well. If they were to start offering, like, big diversified baskets and bring in a bunch of the people that are scared or not ready to diligence an individual name and put money in.
So, I think an index fund, a thematic ETF, like I think that’s the concept that will ultimately unlock the rest of the secondary markets because like nobody’s going to touch…none of the current buyers on these secondary markets will touch a Series B company, but all of them will buy a Series B index fund.
Meb: I could see a family office or an RA or somebody coming to you and saying, “Okay, I’m interested. But you know what? I only want biotech VC investment. Or healthcare, or I only want SAS or I only want seed and Series A sort of level companies.” Do you get those conversations ever?
Dave: All the time. This is where a warehouse line, which is completely unlock us. We could take the preexisting demand, go out and get the inventory and warehouse it until it was fully there and then flip it to the people that ask for it in the first place, in a fund structure, it’s a little bit tougher to do because the predicate of the fund is diversification and discount.
And if we had multiple funds, some of which were biotech-focused and some of which were this other thing, we’d have to have an allocation policy as between them. So, I think we have gotten a lot of demand along those lines and I think a warehouse line is the ultimate solution to those problems.
Meb: Yeah. Thinking out loud, is this something that could ever be like an interval fund or a public-facing just, you know, mutual fund-style vehicle too, or is that too complicated?
Dave: I don’t think it’s too complicated. I think it’s mostly a function of scale. So, once you get to thousands of positions producing liquidity at regular intervals, you can kind of predict your liquidity and then make sure that people are buying in at known NAVs and they’re getting their opportunity to get their liquidity and leave on regular schedules. We will probably grow to the ability to do that.
Meb: Well, it seems like you guys just need to either get a billion-dollar line of credit or get a billion in VC money. So. if you’re a bank head, reach out to Dave and give him big line of credit or some VC interest. Let’s talk a little bit about the horizon. You know, as you build out this product, often as you find a product market fit, which seems like you guys have inside this wedge, obviously you just kind of need to keep doing what you’re doing, is part of the blocking and tackling.
But also, you know, building a product often informs new ideas and kind of how people on the outside, see it. What’s kind of happened over the last year or two as you’ve kind of put this product together where you may have been going down the road and say, “Oh, actually let’s go right at this fork.” This is actually, you know, something that the feedback we’re getting or whether it’s from the investor side, the company side, what have you guys kind of learned and pushed you in a new direction?
Dave: The thing that we have the best line of sight too right now is putting together these thematic pools. So, once there’s enough inventory swashing around our ecosystem, it’ll be easy to take demand on what kind of curated baskets people want to see and it’ll also be easy to fill them. And so I think the moving from a big index fund that tracks, call it the median return of the VC asset class with a little bit of extra juice into a Sequoia basket, and a Series B basket, and a robotics basket, I think that’s the natural evolution for us and it’s very visible to us and it’s purely a function of scale.
Meb: What’s the headcount, man? You guys got start hiring? It seems like this would be a pretty monumental task to… Have you automated a lot of these processes and procedures. Like, how do you see kind of 10, 100Xing what you guys are up to?
Dave: Yeah, so much is automated. So, the 10 to 100Xing is mostly a function of all the data science capability that we’ve started to build up so that we have the know-how to make these baskets without worrying that any of our investors or the requesters of the baskets are going to take a bath. Assume the capital exists, assume the inventory is there, it’s mostly a data science question.
So, we’ve got a team that is dedicated to taking all of the data streams that are coming in. And we actually see an incredible amount of data in this business. So, we’ve got a whole bunch of employees leaving a whole bunch of companies. They all have some insight into those companies that if you put them all together, is pretty impressive. We get to see their behavior on the site.
We get to see whether they’re trying to sell just the minimum number of shares in order to affect their exercise or whether they’re trying to take all their chips off the table. We get to see whether they’re putting any of their own money in, which is an incredible signal. We get to see whether a bunch of executives that are currently employed at the company are doing an option exercise that is otherwise probably not the smartest thing unless they’re aware of something that the rest of the world might not be.
We get to see fair market values for companies, common stock, which is one of the hidden price signals in the VC-backed world. We get to see the employee from our system that helps us find deal flow. And finding deal flow is one use of that system, but also knowing every current and ex-employee across the VC asset class and when they left and when they came and what their background is, is another pretty big data science opportunity for us. So, the scaling comes from capital. Scaling smartly comes from all the data science.
Meb: When you guys are kind of looking at the entire VC space, is there a particular index you guys try to benchmark to. Or when you’re kind of talking about VC, are there any comparisons that you guys kind of talk about or you just say Nasdaq and move on?
Dave: No. For the most part, we use Cambridge associates and the index, the pool of index returns that they produce. And they’ve got a median, they’ve got a top quartile, they’ve got a bottom quartile. So, we’ve got a little box and whiskers around the asset class from Cambridge associates.
Meb: Yeah. It’ll be fun to see. I think it’s an interesting model also experiment on how you could also end up owning the kind of title of…we heard this many years ago, but this concept of not an investible index, but similar. Where if you’re saying, “Okay. Well, who is actually represents the VC index?” There’s a couple replication ones. There’s a couple of some of these hypothetical ones that aren’t investible. I wrote an article, it’s got to be 15 years ago, but you got to be really careful with some of these indexes.
I remember this was on the hedge fund world, but there was between the hedge fund index and then there’s an investible version. And the difference in performance was like four percentage points per year because the index often, the companies stopped reporting their numbers when they did poorly. So, if you’re a hedge fund that blew up, you’re just like you’re depressed and you just stop sending the updates.
Well, they never get those and they don’t make it in the index, and so the index looks a lot better than the investible version. Anyway, I don’t know if that’s the case in the VC world, but you got to take them with a grain of salt.
Dave: Yeah. There’s probably some of that, which is why we’ve put the 25th percentile on the graph as well. But I recently read a book called “Trillions” by a financial journalist named Robin Wigglesworth. And it was about the advent of the public markets index fund. And it seems like such a no-brainer today, but it’s the ’70s and the ’80s and you’ve got to… Electronic training is not quite there yet.
And if I’ve got 100 grand to give you, you’ve got to actually go figure out the right number of units of each stock to buy and then actually put the trades on. And it was not that easy. And I kind of think we’re doing something very similar to that in the private markets. And the point of me saying that is we could end up being the index, and we could be an index that is actually a tradable investable index where there’s no difference between the data bias that you were just describing in like, you know, the numeric non-investible index and the actual asset class.
Meb: Putting on the CMO hat, you could eventually say, “Hey, look, this is the investible benchmark.” And so every single article written from a lot of institutional investor and others will say, “Well, a16z’s fund, this performance compared to the vested, you know, VC, vintage, or index, or whatever it may be, it’s an interesting way to calm the sort of barometer for the industry.
Dave: Yeah, I think that’s right. I think on both sides of our capital-mediated market on the employee side and on the investor side, there are opportunities to do that. So, on the employee side, we’re doing something at a scale that nobody else is doing. And it’s very possible that all the employees end up talking to each other about vested and the flywheel builds over the next couple years while we’re still the only folks that are offering liquidity to the 98% that’s unnerved.
And on the investor side, there’s the opportunity to actually be the index and be quoted all the time. And that both of those things should be self-reinforcing.
Meb: Yeah. Let’s look to the horizon. What’s next for you guys? We are near the end of 2022. Is it all about scale and growth at this point? You got any other screwy ideas, you’re going to expand into Asia, Europe, and South America, or what’s next?
Dave: No, we’re sticking to our knitting and just doing as much knitting as we possibly can. So, you ask what the team was. The team is 15. We’ve got more than enough folks at this point in time to deploy the capital that comes inbound. We just need to make sure that the capital’s coming in and that it’s getting deployed. After that, we will likely go on a hiring binge to support the data team and the scaling opportunities that I talked about.
So, it’s going to be mostly just going out from the dollars that we’ve deployed thus far into that $600 billion market that I described to you. There’s no real need to expand into adjacencies like wealth management. There’s no real need at this point to learn new regulatory regimes in Europe. I think that the road is plenty wide for what we’re doing.
Meb: Yeah. Well, one day. One day you can expand into Europe. You know, to me, it’s fascinating because it seems like an infinite playground on the data side on… I tweeted this a long time ago, but I said one of the best arguments for the private space is simply breadth where there’s at least 10, maybe 100 times more private companies than public ones. And so there’s just so many more out there.
And also if you focus on a certain subset, which is VC-funded and small, meaning, they’re looking for this growth, it’s a playground of numbers and like an okay cubit, sort of analytics you can dive into and find out some pretty interesting information that will inform decisions on what you select as well. So, it’s like a credit reporting model that just gets better over time that others may not have access to.
Dave: I think that’s totally right. So, one of the things that I…from my background, that I personally am the most excited about on the data side, which is what you’re alluding to. So, in my prior startup, a partner and myself, we built a liquid asset pricing model that was operating in real-time and moving with the markets even though the assets themselves were not necessarily trading on a daily basis.
And that model a subsequent version of it is currently and still also trading $100 million book on a retail desk at a name brand bank. And I am sure that we are going to put enough data together from the scale that we’re just talking about to create what I think will be the first or at least the first publicly known pricing model for VC-backed companies.
And it’s a particularly hard problem because the one thing that’s missing about most private companies is the financial. So you have to kind of triangulate the center of the doughnut that’s gone. You can see the employee flows and maybe you can see the FMVs, and maybe you can see the secondary market activity and you can see what the employees are doing and what their behavior is suggesting about their belief in the company. But at the end of the day, you’re still missing the financial.
So, I think we’re going to do that. And when we do, we will start off using it for our own decision-making. And then at some point flip over like BlackRock did with Aladdin and sell it to everybody else.
Meb: You mentioned hedge fund prior career, what’s been your most memorable investment? Anything you look back on, good, bad, in between, and this could be invested, this could be not invested.
Dave: You know what’s funny? You’ll probably predict this, given that I’m running a more indexy type approach to the private markets, but I’ve only made to call it single name or single asset class investments. They’ve both been phenomenal. They’ve both been entirely out of fear or by accident. When I was at Citigroup and their alternative investments swing, which was the hedge fund. That was where the hedge fund that I worked in lived.
I got my first sliver of Citigroup stock, and this was 2000 and I want to say 7. I don’t think it was 2008 but I think it was 2007. And I had been like, on a trading desk. I had completely admitted that every one of these people knew so much more about whatever they cared about than I did that I need to like, not be picking single names ever unless I have a deep amount of conviction subject matter knowledge.
So, I got my first sliver of Citigroup stock and I sold it immediately so that I didn’t have to think about anything. And I sold it at 41 and then it went down to 2. So, that was an incredible trade. And the other great trade was also by accident, which was when we were leaving New York and heading down to South Florida. And we moved down to South Florida way ahead of the great migration. And we bought real estate, you know, three, four years ago and have just benefited from everything going straight up.
Meb: I love it. So, where do people go? Easy question, what’s the best place to find you guys? What you’re up to? If you’re an employee, if you’re a bank, if you’re a giant VC, if you’re a company that wants to partner with you guys, where do people reach out?
Dave: All right. If you’re an employee in need of options funding or limited liquidity around shares that you might already own. head to vested.co. And our diversified and discounted index fund, email [email protected]. Kevin is very well known to Meb. And in fact, set us up in the first place. If you are a bank or a VC interested in a credit line or other major equity investment because you see the forest for the trees the same way that we do, email me, [email protected].
Meb: Seems like you guys can buy vested.com from this title insurance company hanging out in Jersey. Have you guys reached out to them yet?
Dave: No. It’s one of those things that we should revisit every so often, but we put the calabash on like two years ago and now it’s probably the right time to …
Meb: Given their website design and they have one follower on Twitter, I think you probably can get this for a reasonable price. We’ll see.
Dave: Not as soon as the podcast comes out, but thanks.
Meb: You better make the offer soon. Dave, it’s been a blessing. Thanks so much for joining us today.
Dave: Yeah. Thanks, man. I appreciate it.
Meb: Podcast listeners, we will post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at [email protected]. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.