David Zhou, co-founder of The Side Letter and host of Superclusters, shares lessons from his journey as a founder, venture investor, LP, and educator. He explains how sophisticated limited partners evaluate venture funds, why consistent decision-making frameworks matter, and how emerging managers can stand out in an increasingly crowded market. David discusses common mistakes new LPs make, the metrics that matter when evaluating venture performance, and why successful investors develop discipline around both entering and exiting investments. He also shares practical advice for fund managers seeking LP support, emphasizing the importance of understanding investor motivations before ever making a pitch.
David Zhou, co-founder of The Side Letter and host of Superclusters, shares lessons from his journey as a founder, venture investor, LP, and educator. He explains how sophisticated limited partners evaluate venture funds, why consistent decision-making frameworks matter, and how emerging managers can stand out in an increasingly crowded market.
David discusses common mistakes new LPs make, the metrics that matter when evaluating venture performance, and why successful investors develop discipline around both entering and exiting investments. He also shares practical advice for fund managers seeking LP support, emphasizing the importance of understanding investor motivations before ever making a pitch.
In this episode, you'll learn:
[02:35] How David accidentally became an entrepreneur and investor
[03:42] Why venture capital appeals to people who love imagining the future
[06:52] The story behind Superclusters and educating emerging LPs
[11:21] Common mistakes first-time LPs make when evaluating funds
[15:25] Why investors need consistent frameworks instead of chasing excitement
[23:04] Which venture fund metrics actually matter and when
[30:24] The three disciplines every great fund manager needs
[32:25] Why the first LP meeting should never be a pitch
[35:22] How to identify and build a unique competitive advantage
[39:57] Understanding the motivations behind different types of LPs
[44:03] How The Side Letter helps LPs make better investment decisions
The nonprofit organization David is passionate about: Friends of Children with Special Needs
About David Zhou
David Zhou is the co-founder of The Side Letter, a platform that helps limited partners source, evaluate, and understand venture capital funds. He is also the host of Superclusters, a podcast focused on helping emerging LPs learn from experienced investors and better navigate the venture capital ecosystem.
Before becoming an LP and venture ecosystem educator, David was a founder and venture investor. Through his writing, investing, and podcasting, he has become a respected voice on venture fund evaluation, LP decision-making, and emerging manager investing.
About The Side Letter
The Side Letter is a platform built to help limited partners make more informed venture capital investment decisions. The company provides LPs with tools, research, data, and educational resources designed to improve fund sourcing, diligence, and portfolio construction.
By helping investors access better information and stronger evaluation frameworks, The Side Letter aims to reduce information asymmetry within the venture capital ecosystem and empower a new generation of sophisticated LPs.
Subscribe to our podcast and stay tuned for our next episode.
It's about all the things that they could have done better, where they don't have home field advantage. And there are things that everyone talks about, which is like, "Oh, here's how I do my sourcing. I have AI, I go to YC Demo Days," whatever it is. That's what everyone does. But figure out the things for yourself as a GP, and this is really interesting to talk about in the first or second meeting, that you really optimize for, that you are built different in that way, and you then double down.
[00:00:31] Gopi Rangan: You are listening to The Sure Shot Entrepreneur - a podcast for founders with ambitious ideas. Venture capital investors and other early believers tell you relatable, insightful, and authentic stories to help you realize your vision. Welcome to The Sure Shot Entrepreneur. I'm your host, Gopi Rangan. I'm here with David Zhou. He [00:01:00] is the host at a popular podcast called "The Superclusters."
[00:01:05] I'm a very ardent follower of the podcast as well. It's a pleasure to have a fellow podcast host as a guest on this podcast. David is also the co-founder of the SideLetter. SideLetter serves limited partners who invest in emerging managers in the venture capital ecosystem. We're gonna learn more about both of those and his overall role in helping limited partners navigate this complicated world of venture capital. David, welcome to The Sure Shot Entrepreneur.
[00:01:37] David Zhou: Oh, man. It's weird. It's surreal because I've heard your voice in my ear for eons, and I- it's usually, like, a passive. Like, I'm a consumer. I'm not, like, a co-producer of the content that you're producing, and it's weird that you're saying this live and I am hearing it as if I was listening to Spotify. But thank you for having me.
[00:01:59] Gopi Rangan: Welcome. [00:02:00] Welcome. Thank you for that. It's great to hear that you've watched many of the episodes at Sure Shot Entrepreneur, and now you're a guest. Welcome. Where are you from?
[00:02:10] David Zhou: I was born and raised in the Bay Area. Didn't go very far. Went to school in the Bay Area on this very little known school on top of a hill called Berkeley, and then continue to reside in the Bay Area where, let's say, it's the mecca of technology and innovation.
[00:02:27] Gopi Rangan: And you made your way into the world of venture capital on your own.
[00:02:31] Like, you chartered your own path. How did that happen?
[00:02:35] David Zhou: A lot of happy accidents. I got into entrepreneurship because I was eating too much. At the time, I had just finished swimming, and I was eating about 8 to 9,000 calories a day, and I effectively got kicked out of the dining commons.
[00:02:48] But I needed to go find my way and eat still, and so I ended up meeting two individuals who were going through their MBA program at the time who were building a class project servicing local businesses. [00:03:00] And along the way, I ended up joining the team, and we ended up starting this thing called Localize, and that was that.
[00:03:05] And then our first investor for that company ended up being Caroline at Skydeck. And when she was starting off and building her fund as Skydeck was going from nonprofit to for-profit, I was just in orbit enough times. Arguably, I saw her a couple times taking too much free swag.
[00:03:22] I'm a big fan of swag. I have this huge thing where it's like, if it's for free, it's for me kind of thing, and I had that back in college. And so she caught me red-handed taking almost too much swag at hackathons, but that's a longer story for another day.
[00:03:34] Gopi Rangan: What do you like about venture capital, this whole ecosystem?
[00:03:37] What do you like about being an LP? What do you like about VCs? What do you like about startups?
[00:03:42] David Zhou: This is probably not a response I've ever said publicly before. I've journaled about it for sure, but I've never said publicly, which is as a kid, I used to read a lot. Probably still read a lot, but it's a different genre of books now.
[00:03:56] And the books that I loved most were [00:04:00] fantasy and science fiction. I religiously consumed that, and at a certain age, I was consuming about seven books a week purely on science fiction and fiction. And I love the future. I love imagination. And there are very few jobs in the real world that allows you to continue to imagine, and not only that, support where imagination can take us. And maybe this is also the genetics of having two entrepreneurial parents, also being born in the Bay Area. Venture is an industry that allows you to imagine the possibilities and make it happen. And for many reasons, that's why I love it.
[00:04:36] Gopi Rangan: It's absolutely fascinating indeed. We spend time with people who are thinking about the future in a very different way.
[00:04:42] There's so much creativity, so much imagination that goes into those conversations. Sitting down, talking to people about how the future could be, it's very fulfilling. It's very entertaining, at least. Yeah.
[00:04:54] David Zhou: It's like I'm living out storybooks. And when you're a founder, you're the hero of your own [00:05:00] story, but in many ways you're also championing your customers is to be heroes of their stories.
[00:05:03] But as an investor, and I think about this a lot, I think... What was it? I think Mike Maples once said this on one of his podcasts, which is, as an investor, you're more of a Yoda and the founders are the Skywalkers. And I'm not wise enough to be a Yoda, but to be a fly on the wall and to be able to help, even in a little way, a lot of entrepreneurs, and now I help a lot of emerging managers build what they dream of, is fascinating to me
[00:05:27] Gopi Rangan: You were a founder, but then you've switched to the role of an investor.
[00:05:31] And not only just an investor, you're actually educating other investors how to think about this asset class, if you can call it an asset class. It's a very different role.
[00:05:41] David Zhou: It's similar and different at the same time. When we were building Localize back in the day, the thing that fascinated me most... So it was like a marketplace connecting local students to a local business or like collegiate students to local businesses.
[00:05:56] And a lot of that I really enjoyed about building that part of the business is [00:06:00] educating local businesses and also students on what the world looks like and setting expectations for what the world looks like. Because too often, especially even if we take a dating analogy, we go into our first relationship watching Hollywood and Hallmark movies, and we have all these expectations of what love looks like.
[00:06:14] But love looks actually very different when you actually start dating. Similarly true for your career, similarly true for venture, similarly true for being an LP or a GP. And I've always loved the education component of all of this, largely because storytelling. I loved reading stories.
[00:06:32] I'm not qualified enough to tell stories, but I love telling other people's stories and the lessons in which they've learned, and I love to be a student of the craft. And so, yes, the job title probably has changed, but the job description hasn't changed too much.
[00:06:46] Gopi Rangan: That leads perfectly into my next question: What is Superclusters?
[00:06:52] David Zhou: Oh, man! So what happened was, I first became an LP about coming up [00:07:00] on five years back, invested in a couple funds coming out of our ecosystem, out of our community a friend and I were running as part of this larger organization called On Deck.
[00:07:08] And when I first wrote my first LP check, I had no idea what I was doing. I knew the venture game, had been a VC in a prior lifetime, but I didn't know how an LP would underwrite a fund. And so I started asking a lot of really smart people, "Hey. How are you an LP? How do you think about this?
[00:07:24] How do you think about sourcing? How do you think about diligence? When someone tells you they're best in class, when someone tells you they're top quartile, what do they actually mean? Should I take their word for it? Is there a world where I take any of their word for, or should I do all my homework through references?"
[00:07:36] And I had all these questions that I asked people so much smarter than me, from Chris Duovos to Beezer Clarkson to Asher Siddiqui to Aakar Vachhani at Fairview Capital, and they helped me a lot in my journey in terms of understanding what being an LP is like and how to set my own expectations. And so I started writing content a lot on my personal blog around being an LP, and at some point a [00:08:00] couple friends, which to be fair I'll name them.
[00:08:02] One was Asher Siddiqui, who's been on my podcast, who actually helped me start my podcast. One was Eric Tornberg, who I used to work for at On Deck, was like, "You do a lot of this writing. You seem to have a captive audience in this LP base. Why don't you just turn this into a podcast?"
[00:08:16] I was not sure I was gonna start it in the beginning. I don't think I have a radio personality. I don't think I have a podcast personality, but I think I'm a decent writer. And for all those reasons, eventually the straw that broke the camel's back was, I think it was Chris Douvos who I had talked to and he had said like, "Do you know why I started superlp.com?"
[00:08:37] I was like, "No, I have no idea." He's like, "Well, I pitched Josh Kopelman," who I'd invested in, "And then he said, 'Chris, you have nothing new to share except for the fact that you are 10% funnier than the rest of the world.' And that's why I started superlp.com." And I was like, "That's pretty cool." And so I don't know if I have anything new to share, and maybe over time maybe you and other listeners can tell me if I've had anything new to share via my guests.
[00:08:58] But I thought I had [00:09:00] a different personality than most people producing content out there, so that's why I started. And so the whole thesis behind Superclusters is to help the emerging LP think like an established LP, and for me to ask really smart LPs dumb questions.
[00:09:12] Gopi Rangan: Now, what you're doing is phenomenally helpful for everybody in the ecosystem.
[00:09:17] 20, 30 years ago, there were a couple of hundred startups that got funded, and it was difficult to find good founders, invest in good founders. About 10, 15 years ago, the venture capital ecosystem, the VC world, went from, 100 to 200 VC firms to many hundreds of VC firms, maybe 1,000, 2,000 VC firms, and now I think we're touching close to 4000 or 5,000 VC firms.
[00:09:41] And that has invited a lot of new LPs into the ecosystem. The LP world used to be mostly fund of funds, established limited partners who understand how this ecosystem works, maybe endowments and foundations who put a lot of effort into actually helping create this whole ecosystem in the early days.
[00:09:58] Now there are many different [00:10:00] types of LPs, so it's very important to disseminate knowledge and gossip and stories to help people understand what is this like, how to deal with startups, how to deal with VCs, how to choose the right kind of VCs. And you're doing phenomenal work to bring more knowledge into the ecosystem.
[00:10:18] Thank you for doing that.
[00:10:19] David Zhou: And part of this is also, on that last point, that one of the books I had read, and I believe that was Scott Belsky's Messy Middle, which is actually a great product book, by the way. But there was a line in there that he had cited, and I forget if it was citing Mike Maples or Eric Schmidt, but it's one of the usual suspects, where he says, "Truth is about what is right. Ego is about who is right." And I think so much of social media is about who is right as opposed to what is right, and part of the reason for content, Superclusters obviously highlights the who, but a lot of the content at broad, whether it's the blog or just social media content that I do put out there, is about what is right.
[00:10:59] And you come [00:11:00] to your own conclusions on what is right. Is there a rationale behind it? Does it make sense to actually believe in that why, the how, and the what? But it's not necessarily about, oh, like, it's because this person said it, and that's why that is a truism.
[00:11:12] Gopi Rangan: Now, I follow your podcast and I also follow you on LinkedIn. You have a lot of zinger posts, controversial takes on how this ecosystem is evolving.
[00:11:21] Let me ask you a simple question first. What are some level one mistakes that new LPs make when they enter into this ecosystem? What do they not understand?
[00:11:32] David Zhou: I'm gonna be pretty quick there and we can dive deeper where it makes sense to. So they make that many mistakes. We can go for podcast. They make a lot of mistakes. We could do a Lex Fridman podcast style on purely the mistakes that people make, and this is true for, like, when VCs first start, this is true for founders when founders first start.
[00:11:48] LPs are humans at the end of the day and we make a lot of cognitive mistakes. The early days, and I was prone to a lot of this, admittedly didn't invest because I learned from my venture side, which my first angel investment ever [00:12:00] was to the first founder I'd ever met. Didn't work out that well.
[00:12:03] Second company ended up doing a little bit better. But one of the big lessons is most LPs, especially when you've gotten to a place where you're high net worth or you're plugged into Silicon Valley or you're a family office or an institution and you're just starting your career or in that, it is very easy to fall in love with the first few pitches in which you get.
[00:12:21] The truth is you might get, like, really good pitches, and they might be some of the best managers that are out there. But without actually doing the homework, you have no idea what quality looks like if you've never seen the market. And so one of the elements that I often recommend LPs or just any investors is you should probably talk to at least 30, 40 in that asset class, in that type, before you make a call.
[00:12:43] And the beauty of LP to GP, which is different from VC to founders, founders raise on a very short time horizon. If you miss the seed round, you have to do Series A. If you miss the Series A, you have to do Series B. There are like time horizons of when that happens. And depending on how much traction they have, you probably have a couple weeks, maybe [00:13:00] a couple days, at best, like, a couple months to make that decision.
[00:13:03] On the flip side, for LPs, the average fundraising cycle is 12 to 18 months, sometimes longer these days. The fundraising cycles are super long, so you can take the time to talk to a bunch of people before you make your investment.
[00:13:16] I wouldn't recommend get- coming at the first close. There's all these, like, nomenclature of why first close makes sense. I'm a first close LP, but I have my reasons of why I'm a first close LP. But for the most part, if you're just starting off, it makes more sense to be the final close, but not final close just because whoever else is investing, but because you've talked to a bunch of others and you've realized the one you're putting your money behind is the best one out of the, let's say, 30 you talked to.
[00:13:37] So I would start with that, and there's also a lot of bias towards, "oh, I spend a lot of time with certain individuals," and there's a bias towards, "oh, because I spend that much time with these individuals, I tend to like them a little bit more." Sometimes the best investors are, I don't know if it's sometimes or oftentimes, but sometimes the best investors don't always give you the time of day, and if your primary motivation for being an LP is financial gain, [00:14:00] then it's not about who you spend the most time with.
[00:14:02] Obviously, a lot of LPs invest for a lot of different reasons, monetary capital, intellectual capital, social capital. If it's like intellectual social capital or like deal flow purposes, yeah, it makes sense that you probably should spend like more time with certain GPs and hopefully they like you as well.
[00:14:16] I'm gonna pause there, but that's just some of the mistakes.
[00:14:19] Gopi Rangan: I wanna go more. I wanna keep going. So first, spend a lot of time. Don't fall in love like a tourist. Spend some time, get to know the field, understand the market, meet 30, 40 GPs. Once you understand how this works, then you will form your own flavor taste for what is a good fit for you. And when you meet these GPs, figure out what is it that you can expect out of this investment.
[00:14:46] Now, financial returns is obviously one, but there are other things that you can get also, and sometimes those things might be more valuable to you than the financial returns itself. And the financial returns, when it happens, if it happens, [00:15:00] it'll be very long term, like 10-plus year commitment with the first fund and hopefully with multiple funds.
[00:15:06] Now, if you back the GP the relationship goes on for more than a decade easily. So then you need to be very patient, and meanwhile, you look for other types of things that you could get: social capital, network, intellectual curiosity getting satisfied, many other things. So think about it holistically, not just from one angle only.
[00:15:25] What else?
[00:15:26] David Zhou: There are other things where it's like there are tax implications or business reasons or legal reasons to pass on a certain opportunity just because it sounds good. For example, if you're a family office that cares a little bit more about QSBS or a high net worth individual that cares about QSBS, qualified small business stock, which means you have zero capital gains after five years up to $15 million, but now there's like, like step-ups from three years, four years, five years.
[00:15:48] If that matters to you and for the check size in which you write, if let's say it's a 10X fund, it'll still be less than $15 million, like in terms of your return, then in that case, it might make sense for like you to double down on QSBS, [00:16:00] which means any, let's say, any fund that is doing reserves and also like, "Oh, I also do Series A investments and onwards," might not be a good fit because the chance of you getting QSBS on those opportunities are far less. And so that means you might see a good Series A, Series B investor, but not a good fit for you because you're, let's say, largely there for capital gains like 10, 15 years out.
[00:16:20] And so there are like a bunch of reasons as to why to do so. It's really helpful to talk to folks. In general, it's helpful to have like some friends in the ecosystem who see a different subset of opportunities that you do. And as long as you have like non-exclusive overlap for deals in which you see a lot of, like, chat about them, learn about them, is super, super helpful.
[00:16:39] So those are like, I wouldn't say mistakes, but things to be aware of when you start. Everyone will say they're top quartile. Everyone will say they're top decile at this point. You cannot believe that, unfortunately, because one of the mistakes... I wouldn't say mistake. I get why it exists, which is there are a lot of managers, and I dare say most fund ones and fund twos use [00:17:00] safe markups as part of their TVPI, MOIC count.
[00:17:05] And then they'll compare that with, say, Carta's benchmark. And I don't know if Peter, if he's listening to this, like he can correct me if they're actually using safes or not in terms of their, like, benchmarks, but I'm assuming, I'm gonna take the benefit of the doubt, I'm assuming Carta doesn't use safes as part of their benchmarks because that's industry standard and, like, best practice not to include safes and only price.
[00:17:22] Gopi Rangan: But- They don't ...
[00:17:23] David Zhou: so in general, like, let's say you're four years out and you're like 1.8X. 1.8X looks pretty damn good, but if you include that, like safes, but it really is only like, let's say, 1.4, it's like not bad, but I don't think you should lie about it. That said, I know since most people do it, even good and honest people end up using safes as part of their markups. My recommendation, if you're an LP, is like, "Hey, here are your marks.
[00:17:45] Send me your SOI (schedule of investments). I'll do my own marks. I'll value them myself. Let me know which ones are safes, let me know which ones are priced." And on top of that, you have your own val- valuation methodology. For example when someone goes, "Oh yeah, we're like 3X on our money," kind of thing, and you realize one of the [00:18:00] primary drivers for that 3X TVPI is an investment they made three years ago that hasn't gotten repriced and, to your knowledge, doesn't have any revenue growth, it probably isn't fair to hold it at last round valuation.
[00:18:12] And so you probably need to do a preemptive kind of 30%, 50% markdown depending on the kind of business it is. And I mean, actually, funnily enough, I was just chatting about this morning. There's this website that has been making the rounds in the LP groups that I'm a part of, but there's this website called deathbyclawd.com.
[00:18:26] Clawd is spelled C-L-A-W-D.com, and it pretty much, you put in the URL, you put in the company, and it tells you how likely Claude is going to overtake that company. All that to say, if someone's invested in the SaaS era, so we're looking at, like, 2017 to 2019 vintages, and they go like, "Oh yeah, I'm really bullish on this company that I've held for a very long time," and their last round valuation was, say, 2023, and maybe it was a flat round, it probably isn't fair for them to hold it at last round valuation, even though that may look better for their numbers.
[00:18:56] So that's just some things to be aware of. Also, having [00:19:00] a framework that is consistent is really important. It's very easy to approach every single conversation with like, "Oh, here's like a net new set of questions," because it's based on the conversation, go with the flow. But at least have like two or three questions or two or three things you look for that is always constant across the board, so then you can compare apples to apples instead of apples to oranges.
[00:19:16] So there's a couple things there, and I, but I see a lot of people go like, "Oh, I really like this person for their deal flow. Oh my, I really like this person because they had a good track record." And I'm like, "Well, if you can only pick one, stack rank them. Which one do you pick?" It's like, "Well, they were both good in different ways."
[00:19:29] I'm like, "That's not helpful in terms of being an investor, and everyone is good in their own way. You have to pull a judgment at the end of the day because you only have finite capital."
[00:19:36] Gopi Rangan: There's a lot of wisdom here, so I'm gonna parse it, try and learn as much from the knowledge you're sharing here.
[00:19:42] First There could be QSBS benefits, and if that matters to you and the timeline of investments when the VC invests matters. If the entry point is pre-seed or seed, it's very high likelihood that the investment will be held for more than five years, which [00:20:00] typically lands around Series B, Series C time. So if there's an acquisition or hopefully if there's an IPO later, year eight, nine, 10, you'll get the full benefit out of QSBS. If the same VC not only invested in seed and Series A, but also invested in Series B and C in follow-on rounds, there's a part of the capital that will benefit from the QSBS, but there's a part of the capital that entered into this company at Series B or Series C. By the time the exit happens, it might be another two or three years later, but not the full five years, which means that the LP doesn't get to benefit from the full benefit of QSBS. So this is something-- I know this is technical and nuanced, tax planning. We're not giving tax advice here, but if you're an LP who is interested in that, then you must prioritize VCs who invest early and only invest early and do not invest later. So that's something to keep in mind.
[00:20:57] The discipline and the consistency of using [00:21:00] filters to choose the kind of VCs to back, that needs to be maintained across all decisions. Now, you cannot make a decision saying, "I like this VC because, there's a sector focus or geography focus," and you choose another VC because they have better deal flow and you get excited about the AI darlings they have in their portfolio.
[00:21:22] You cannot get excited about different things about different VCs, although you will see a lot of VCs who are so different from each other on how they operate. Your process as an LP to filter, to decide who to invest in needs to be consistent. That way you can learn from one relationship and take that lesson into the next relationship, and you can build a comprehensive portfolio.
[00:21:43] Some VCs don't do that because they get really carried away by the charisma of the VC or maybe some numbers that need to be peeled to the second and third layer. They don't do that, and the VC shows in their slide deck, TVPI and MOIC and- Yeah ... the top [00:22:00] quartile, top decile, and none of those things really tell the full story.
[00:22:04] David Zhou: Yeah. And it's also like the truth is top quartile whatever metrics TVPI, DPI makes sense, but like every- any TVPI RR numbers can all be gamed in the first five years, and so it's important not to over optimize for the first five years benchmark and really like TVPI like makes a lot more sense after you're past like year six, year seven.
[00:22:22] But until that, like lemons ripen early, you don't know where marks are and all that kind of stuff. One thing to talk about in terms of the filters also is, if you're trying to be a better investor, it's important to us have a set like frameworks and inputs, right? You can change your inputs, but your framework should stay the same.
[00:22:37] Your input should stay the same so that you can learn, right? And a lot of this is like the rules of the game, at least the ones you decide for yourself, have to stay the same in order for you to improve. You cannot get better at Monopoly if you play Monopoly one day, UNO tomorrow, Catan after that, and Mario Kart after that.
[00:22:51] You have to play Monopoly again and again before you get good at Monopoly.
[00:22:55] Gopi Rangan: The input and the strategy needs to be consistent. At what point [00:23:00] would you start looking at metrics? Is it year four, year five, year seven?
[00:23:04] When is it noise and when does it begin to give you signals?
[00:23:09] David Zhou: There are metrics that I think are helpful to look at, and there are metrics that I don't think are helpful to look at in the early years. Let's say 15 years out from the fund, obviously any DPI number is set in stone. Realized IRR is set in stone. That is the optimal metric to be looking at, right? Although you do have to then assess, like, is that GP's best days ahead of them or behind them? Because if they've been really successful and they have a lot of wealth, are they working as hard as they used to?
[00:23:30] That's the thing you have to assess. But at least in terms of metrics, DPI and realized IRR are already there. And then you work backwards to year 10. Year 10, you're like, okay, you have some amount of TVPI. You're probably selling like anywhere between 25 to 50% into DPI as well because you're, you have some realization there.
[00:23:46] And so DPI is also a strong number to look at, but you probably still have some residual TVPI in some of your greatest winners. Really if you have a couple good wins, the distribution of DPI to TVPI is actually, like or RVPI, [00:24:00] residual value, is much higher. But if you don't have good winners in that fund, that's okay.
[00:24:03] Every so often you won't have good winners in that fund. Then you'll just be like, "hey, you know what? The DPI is a larger proportion of the TVPI pool, right? And those are things you look at that time.
[00:24:11] But if you look at the early stages- Is that Okay? To have early DPI and RVPI is low, which means that the fund is doing okay, but not gonna be, you know it's not gonna be
[00:24:21] great Well, it depends, right?
[00:24:21] There are certain industries that realistically might take a long time for a exit time horizon, so like deep tech, life sciences, likely a longer time horizon. But at the same time, like if you look at life sciences per se, like usual exit sizes in the past like five years have been like 500 mil to $2 billion.
[00:24:38] So technically should realize by like year seven, year eight kind of thing, assuming you invest in year one. But there are other industries that are zombie businesses, and it's sometimes it's better to sell into the next round as opposed to keep holding for the wish that it might be something else because the memo and I go back to something that Jerry Colonna once told me, which is like it's, the memo is buy low, sell high, not buy lowest, sell highest. [00:25:00] And yes, you can always like, "Oh, yeah, it can go even higher. Yeah, it can go even higher," but as a fiduciary of capital as a VC, getting to a 4X is probably good for, like, decent enough for a lot of people.
[00:25:12] And yes, there's a potential for an 8X or a 10X kind of thing. But you also f- like, do the calculation of if you sell now, if you sell 30%, 50% now, how much do you actually cap your upside? And the realization actually for a lot of opportunities in which you can sell is you're probably capping at most one to 2X DPI on the upside if you sell early, some percentage early.
[00:25:32] Obviously, there's many methodologies of sell on the way up and all this kind of things, but that's something to think about. I will say your question I think is more interesting when it comes to like the first two to five years, what are the metrics you look at? TVPI, DPI, IRR, everything that could be on there will not be obvious on there, so it's, there's almost no point in looking at any of those metrics.
[00:25:52] I think what's more interesting is like graduation rates because part of your job, let's say, as a seed investor is to make the obvious. Are you helping your [00:26:00] companies go from one stage to the next? Are your companies going from seed to series A, 30%, and then like 30% of those going to seed to series A, is 50% going from series A to series B? And in general, you should probably have like 15% of your seed investments get to a series B. Like, those graduation rates are probably a lot more interesting as opposed to pure marks.
[00:26:16] I think AngelList has this, a metric where it's like markups to baseline kind of thing, which is something you can look at. But something else is like going back to the actual company that help the portfolio health is like how much is revenue growing? What is their net retention? So you almost have to be like a VC, which is their revenue growing at a reasonable pace that justifies their valuation multiple?
[00:26:36] Is the retention high enough? So like 120% net revenue retention or higher would be amazing. Obviously, with some of these frontier labs, they have like insane retention. I think it's like, I don't know, a couple hundred percent or something like that. Don't quote me on that, but it's directionally accurate.
[00:26:48] But is retention there versus like let's say the next video generation, image generation platform, which is great for like the first 90-day spike because you have free trial and you like onboard yourself for the first two months. But after that, the [00:27:00] retention like slips below 50%, which is actually quite bad considering how much of a hype AI is, which means you have a leaky bucket.
[00:27:06] All that to say is you probably wanna check the portfolio health, and if you choose to invest in a certain industry, it's helpful to also talk to other VCs, established or otherwise, in that industry of what metrics they're using to underwrite their portfolio for you to have a better sense of how to evaluate other people's portfolio.
[00:27:22] Gopi Rangan: When do you begin to expect to see DPI? Is it year four, five, six, seven? Year seven goes by and there's zero DPI. Year eight goes by, there's zero DPI. Does it bother you?
[00:27:33] David Zhou: It's honestly a case by case, and that's probably not the answer that you wanted, but I'll elaborate on why it's a case by case. In the first four years, you might get some early exits.
[00:27:42] Let's say you invest in a 10 mil post and then some company goes, "Hey, we'd love to acquire you for 40 mil," or something like that, or 50 mil, and then you get like, gross 4X, 5X on your money, I'm obviously like smudging the math a little bit. But it'll probably be less than a 25% DPI on your fund size, and that's [00:28:00] not exactly meaningful.
[00:28:00] That's within your recycling period, then the discussion comes down to do you recycle that money or do you like return the money back to your LPs? And it's like relative cost. I think Howard Marks wrote a memo on this a while back, which is if you have another great opportunity that you can immediately put your money in, let's say it's a... using the 1031 exchange methodology, do you have like a 90-day window to put that money somewhere else? If you do, go do that within the first four years because it's not meaningful DPI to anyone. If you don't have that, return that money back, right? And so DPI matters a little bit if you have less than 25% DPI, but not really.
[00:28:32] Like honestly no one cares for like, you put a dollar in and get 25 cents back, even if it's 25 cents. Past the 25 cents on a dollar, when you get to like the 50 cents on the dollar or like, a dollar for a dollar kind of thing, the time it takes you to return that allows the LP to better budget and figure out their drawdown schedule, which allows them to, A, either reinvest into your fund into future funds, which is good for you in the future, or B, it's just like, "Wow, I got my money back.
[00:28:57] This is better than like market return." [00:29:00] Because if you invest in S&P or VOO, QQQ, these kind of things, where reasonably you can probably get to a 2.5, 3X after 10 years, assume like 10 years synthetic kind of cycles. First four years you put 25% capital, for the first four years, and you wait till the last 10 years to like take it out.
[00:29:15] You could probably get 2.5, 3X, give or take. And so venture needs to be better. And so 1X DPI is actually pretty damn good if you're a year five. Usually by year seven, you're... should be like .75 to one. That's what's to be expected. If you don't have that, it either means you have a trash portfolio, which happens, or you have some serious winners, but the optionality to be able to sell into like, oh, like our... like we have early SpaceX shares, we have early OpenAI shares. We could sell, which like there's a secondaries market for that. The option to sell is more important for the LPs. Then it's up to the LPs if they want to exercise the ability to, for you to like, sell a piece of their LP stake out in the secondary [00:30:00] market into your fund.
[00:30:00] But that's like a whole gamification of that, what that world looks like. All that to say, it's like if you're year eight, nine, and you have less than 1X, I have big question marks.
[00:30:12] Gopi Rangan: This VC asset class is getting more and more complicated. I know ... the M&A and IPO used to be the main source of liquidity, but now there's the whole secondary market that's coming up as startups stay private longer and longer.
[00:30:24] David Zhou: To wrap up that point, I think of three things when I underwrite managers, right? Like, obviously there's the usual sourcing, picking, winning, supporting, exiting kind of thing. There's other people have like the four Ps. It's, actually it's like philosophy, performance, people, like things like that, right?
[00:30:38] It's important to build your own philosophy. You can leverage other people's philosophy in the early days. One of the philosophies that I have personally, feel free to copy, don't have to copy, whatever, is I have three Es for discipline, and you need entry discipline, exit discipline, executional discipline, right?
[00:30:52] Entry discipline is, as what most managers say, we get in like this ownership up front, we get in at this post-money valuation. We said we're gonna [00:31:00] do 25 companies, we've invested in 26 companies. It's like roughly the same, right? And then we're like, we're value add along the way. Exit discipline is like, when do you sell?
[00:31:07] Like yeah, it's easy to say like, "Yeah we'll consider secondaries." But like when do you sell into secondaries? Do you sell into the next round of investors? How much of your secondary should you sell? Should you sell 30% of your stake, 50% of your stake, 100% of your stake? At what point does it actually make sense to?
[00:31:19] There's actually more of a science plus art behind that, but having a prepared mind, so to speak, to think about exits is important. Obviously things can change, but having a prepared mind helps. Third part of this is executional discipline, which is the delta between net and gross return, right? Which is investment into organization.
[00:31:34] Like how much are you actually spending? Are you hiring the right people? Do you have good processes? Yes, you have AI internally, but does your AI actually free you up to do other things, and does it like allow you to save on costs? I don't know, right? But all that to say like it's important to have those three considerations if you wanna be a fund manager as opposed to just a good investor.
[00:31:51] Gopi Rangan: This leads to the theme of how to build a firm and not just think about generating returns on one or two deals or making one [00:32:00] fund successful. Over the years, there are now so many new VCs who have entered the ecosystem, and there are so many new LPs who've entered the ecosystem. Now you and me are good examples of that.
[00:32:13] As you meet a lot of these new VCs, emerging managers, what can they do to make the conversation with an LP more effective, more productive when they meet an LP?
[00:32:25] David Zhou: I have a take on it, which I know for a fact most people may not like. But it makes sense. I think every LP would agree with that statement. Many GPs will not agree with that statement, which is the first conversation- Okay, let's roll Like, I don't call it a hot take because I actually think it's a colder take than one thinks, but most people don't do it, which is the first meeting you should never pitch.
[00:32:47] There's ... Siqi Chen has this thing, who runs this company called Runway Financial, wonderful company, how do you storytell with finance? I think it's a really smart idea. I think he's also a great storyteller himself. Like, the number of times I've seen him on [00:33:00] founder, like, investor updates of like, "Oh, Siqi Chen has been super helpful in terms of our branding and, like, marketing and all these kind of things," is incredible The reason I bring him up is he has this thing, which I once saw in a presentation that he did, which is people think people make decisions by they observe reality, then they collect facts based on the reality. They form opinions based on the facts, based on the reality, and then they make decisions based on the opinions, based on the facts, based on the reality. The truth is, and let's be honest, VCs are in this bucket as well because it's the same for, like, founder pitches, which is the truth is we all start with opinions.
[00:33:34] We all come into our lives with opinions. Call it nature, call it nurture, I don't care what you call it. It's an opinion. We start with opinion. We find facts that fit in that opinion, and then we make decisions that make us feel good, and that's how people actually make decisions. It's true for VCs, it's true for LPs.
[00:33:48] And I think sometimes VCs forget it when they're on the sell side of the table instead of the buy side of the table. It's weird. But all that to say is LPs are human beings. They want to know about you, [00:34:00] right? There are several things that they love to share, and also it's important to spend more time learning about the LP as well.
[00:34:05] If an LP only buys peaches and you sell it sell the LP apricots, makes no sense. Not a good fit. And so this is the thing I did when I was in IR. Your mileage may vary, may be different, which is I believed in 15-minute meetings and two-hour meetings. It's either a 15-minute meeting or a two-hour meeting.
[00:34:22] There's no 30-minute meeting, there's no one-hour meeting. A 15-minute meeting because it's all you really need to understand if someone's a good fit, and it is, like, ask a bunch of questions, don't talk. Like, really just ask questions, figure things out, and then before the 15-minute meeting's over, figure out for yourself and honestly be intellectually honest, like, if you're actually a good fit or not.
[00:34:42] Obviously, you have to figure out your right questions to ask for that. And the two-hour meeting is, like, let's get to know each other deeper. Let's get to the nuance behind things. But the 15-minute meeting aligns on two things: one, strategy, two, timeline. If the LP doesn't align on either of them, it's not a good fit, right?
[00:34:54] There are some LPs out there, especially pension funds and large foundations, who are like, "Oh, yeah, we take two and a half years to make a decision." And [00:35:00] you're like... You're thinking, "Oh, my first close is in three months. I don't have two and a half years." You're not gonna force them to change their thought process.
[00:35:05] Yes, people make exceptions. Don't expect you're the exception. Everyone's exceptional, right? And so there's that element of it. But a lot of this is if you're a fund one, fund two, let's just say you have a very little track record and you're not, like, a spin out or something, the truth is We're betting on the people just like you're betting on a pre-seed founder.
[00:35:22] Like, there's no traction that makes it obvious to bet on a pre-seed founder or an inception stage founder, which is the nomenclature these days. And so it's so much more important to understand how you think about things. For me, I take a lot of inspiration from the hospitality industry, and I remember there was this story, I don't know how much of this is myth now at this point, when Eleven Madison Park in New York, wonderful restaurant, three Michelin stars, I think s- maybe has, still has three.
[00:35:47] I haven't checked recently. Anyways, wonderful restaurant, very expensive, $1,000 per person kind of thing. But when they had first made it onto the top 50 list, I think it was like New York Times top 50 list, [00:36:00] and they're like number 50 out of 50. This is like potentially 1990s, early 2000s. I forget the timestamp on this.
[00:36:05] And what happened was, I wanna say it was Will Guidara on the team. It might've been Danny Meyer, but it was someone on the team who said, " all hospitality staff, I want you to go to every other restaurant on the top 50 list, all the other 49 restaurants And then we'll debrief after every single restaurant you go to.
[00:36:21] And so they go to all the restaurants, and the debrief is not about, oh, like, Le Bernardin did this thing great. French Laundry did this thing great. No, it's not about that. It's about all the things that they could have done better, where they don't have home field advantage.
[00:36:33] And there are things that everyone talks about, which is like, "Oh, I-- here's how I do my sourcing. I have AI, I go to YC Demo Days," whatever it is. That's what everyone does. But figure out the things for yourself as a GP, and this is really interesting to talk about in the first or second meeting, that you really optimize for, that you are built different in that way, and you then double down on that.
[00:36:52] So eventually, what happened at Eleven Madison was, like, they took a whole list of everything that all the other three Michelin star, two Michelin star places didn't do as [00:37:00] well, and they doubled down on that, which eventually led them, at one point in time, I think Eleven Madison became the top restaurant in the world.
[00:37:05] And so part of it is that, like, find out where you don't have home field advantage and really double down on that, like really refine that skill set. And then share that with the LPs of like, "Look at my thinking of how I think through this." And I think the thinking behind how you do things outside of just the what is far more fascinating than purely the what.
[00:37:23] Gopi Rangan: That's kinda what I did when I started Sure Ventures. I felt like this whole insurtech space is new and different, and no VC is specialized in this, and no one has home field advantage, so I'm gonna build something. But now in-- I thought that this is gonna take some time to warm up, but this insurtech space has become really big very fast, much faster and bigger than I expected.
[00:37:46] Oh, yeah. And I get to do one more round of eating at 49 Michelin star restaurants to figure out- ... what's my new strategy and new home field advantage.
[00:37:55] David Zhou: Well, actually, I think it's really fascinating because for some reason I've see- I'm seeing a lot more of this, [00:38:00] which is other GPs going to other GPs AGM.
[00:38:02] Easier to do if you're, like, an emerging manager, harder to do if you're an established manager, or like es- like established manager going to established manager's AGM annual general meeting. But if you have the opportunity to go to other people's AGM, like obviously don't shit talk them. Be happy that you got an invite. Like, you're trusted enough that you got an invite. But, like, as you're spending time there and talking to folks and also analyzing what they say at their AGM, what makes their firm special, figure out how you might be different from that as well, and take that as a fortune and a liberty as well.
[00:38:30] Gopi Rangan: I have a question. I'm gonna take a stab at LPs. The startup ecosystem has founders who have agency. It's their business, and they are the principals of the business. Emerging managers are very similar. It's their firm, and they are the principals- Yeah ... in their business. They have a lot of agency. In the LP world, there are very few LPs who actually have agency.
[00:38:56] Maybe family offices have a lot of agency, individuals have a lot of [00:39:00] agency, and they are the principals of the decision-making process. But there are a lot of other institutional investors, LPs, who are not principals of that firm at the entity. They are agents performing on behalf of an institution.
[00:39:16] Personally, I have carved out a way to engage with founders because it's a principal-to-principal conversation.
[00:39:24] David Zhou: Yeah.
[00:39:25] Gopi Rangan: And when I talk to LPs who are also principals, I can transfer that skill and have a good conversation. How do I learn to be useful to agents who are not principals and LPs making decisions on behalf of institutions?
[00:39:41] There's a big difference here in how they make difference in how they act and how they work.
[00:39:46] David Zhou: I dare say some founders can say probably the similar thing about VCs. Obviously, it's different for, like, if they're pitching you, Gopi. But if they're pitching, say Andreessen has so many folks there- I agree
[00:39:56] Gopi Rangan: with you.
[00:39:56] It's the same thing.
[00:39:57] David Zhou: Yeah. If you're talking to a- Yes ... like maybe, and not Andreessen, but like [00:40:00] also if you're talking about a principal at another multi-stage fund. They don't have as much agency as they would like, much less an associate. And so I think it's a really good question. There was something that maybe last year, a conversation with someone you might know as well Matt Curtolo, that really, like, helped me come up with this framework.
[00:40:17] But he had this framework which is, like, there are asset allocators and there are asset owners. Asset allocators are, in your opinion, like, agents, and asset owners are the principals, right? High net worth individuals, family offices are asset owners.
[00:40:29] Matt made it really simple. I made it even more complicated, and I was like, "Matt, I think there's more than two personality archetypes in the LP world." And I hate to do the Myers-Briggs thing, but I effectively did the Myers-Briggs thing on top of Matt's original methodology.
[00:40:42] And I said there are asset allocators. Like, think about X, Y Cartesian graph. X-axis, there are asset allocators, there are asset owners, and there are asset originators. Like, asset originators are people who created the wealth. Just because you own the wealth doesn't mean you created it. Like, a generation five at a family office, [00:41:00] even though they're a principal, does not understand what it means to build a business and to build a generational business as a generation one or a high net worth individual who, like, is the sole breadwinner for the family, right?
[00:41:10] So I think there are, like, asset allocators, professionals, asset owners, asset originators. On that, then you have the Y-axis. The Y-axis, I then transpose Maslow's hierarchy of needs, which is it starts at the very bottom with physiological needs, which is like, I need a home, I need shelter, I need, like, very basic things.
[00:41:28] I need food. Then you have safety, then you have love and belonging, then self-esteem, then you have self-actualization. The truth is, if you're an LP, you're probably not the physiological stage. Like, there's just... That doesn't exist. You can't really be an LP if you're at the physiological stage, whether you're junior or senior on the totem pole.
[00:41:46] But for the other four kind of, like, things on the Maslow's hierarchy of needs, some kind of LP fits on that. So there will be, like, asset owners who really seek love and belonging. They might be the next gen of the family office, and [00:42:00] they have three siblings, and out of their three siblings, they're not the oldest one, but, they want their parents to respect who they are.
[00:42:06] And maybe they lived a less franchise childhood or something, and, like, they really wanted to prove themselves to their family and to their friend circle. Like, hey this is something at a family office, next gen family office once told me, "I wanna be defined by my first name, not by my last name."
[00:42:19] And that love and belong, potentially self-esteem, is something even though they're an asset owner, in this case like a family office principal, they still want. They're not a hired gun. It is their money. They can make decisions. But how they make that decision, the motivation behind that decision is different from someone who's a CIO at a multi-billion dollar foundation.
[00:42:36] And that proof is really social capital. Like, what can I do in the very near future? I don't care about long-term futures. What can I do in the very near future that will help me get the approval of family members as well as friends? And sometimes that is knowledge acquisition, right? That is like, "Oh, I know more about the AI space than all my friends do."
[00:42:55] Sometimes it is about, "Oh, I get to co-mingle with some really impressive people," or that [00:43:00] really impressive people trust me to do this thing. Or if they're building something themselves, a lot of family office folks also, like, build their own side businesses, like next gen folks also build their side business.
[00:43:08] This side business helps me be a lot more meaningful to the ecosystem and gives me a lot more purpose. But that decision-making is different from family office principal who's the most senior person, who's the heir to the family or like, most senior person in the family who can make like, "Hey, we wanna do this deal, we just do this deal," right?
[00:43:24] They're proving different things to different people. And so all that to say, like all the LPs you talk to is somewhere on those 12 personalities, and it's important to know what motivates each personality so then when you have a pitch or when you relate to someone, you can relate to them with respect to where they wanna go next.
[00:43:40] Gopi Rangan: This is a very useful framework to think about how to classify LPs, but I think it's good to use a framework like this to classify all relationships. It's very helpful. I want to learn more about the SideLetter. I believe a lot of what you've talked about so far goes into the advisory work [00:44:00] and the support you give to LPs.
[00:44:01] What is SideLetter?
[00:44:03] David Zhou: I'll take a slight step back. I'll relate why Superclusters and SideLetter are similar but different. Superclusters I started a couple years back because I thought it was important to empower everyone with the frameworks that institutional and sophisticated LPs have. And there are three kinds of things.
[00:44:21] There's inputs, frameworks, and outputs. You can never control the outputs, so just we'll throw outputs out the window for a second. For purposes of compliance and SEC regulation, all these other things, I can't really share the inputs on the podcast, especially on a public platform. And that was something that was, like, really unfortunately, I couldn't do in a public space.
[00:44:39] SideLetter, I started this with Sam Huey, who I used to work with at OnDeck, and I love him dearly to death, and he is such a mind that I am not. He is operationally rigorous, which unfortunately I wish I was a little bit more of. He builds things and he's a bias to action that sometimes I, like, I was like, "Damn," like, "Sam, you..."
[00:44:56] Like, we talk about something, and then, like, an hour later, he's like, "I'm done. I did it." A- and I'm like, [00:45:00] "Oh, my God," like, "this is crazy." And so in many ways, like, I don't know why Sam's working with me. I know why I'm working with Sam, for all those reasons.
[00:45:06] With SideLetter, the thing we wanted to pursue was the inputs portion of this, which is it is purely for LPs. It is a subset of, like, private data sets. It is also, how do we empower LPs to leverage some of the frameworks with some of the inputs in which we have? And it is, like, very data heavy. We've built certain things recently for our customer. We built, like, a fund to funds market map because they were, like, a large multi-billion dollar family office, and, like, we have zero exposure to venture.
[00:45:32] And I was like, "Do you have a CIO? Do you have a head of investment?" Like, "No, we don't have any of that." And so I was like, "Then if you want emerging venture, if you don't want to talk to at least 200 funds a year, fund to funds might be a good play here." Like, pure play fund to funds, emerging manager, that kind of thing.
[00:45:47] And depending on your interest, so we ended up, like, building a fund to funds market map for her effectively, and eventually, like, we ended up doing some other things. All that to say, SideLetter is where we empower LP curiosity, [00:46:00] where we build not only tools for LPs to better diligence things, better source things, primarily focused on sourcing and diligence right now.
[00:46:07] But also to, in this asymmetric information world, how do you have more symmetry of information? So that's what we're building at SideLetter. Happy to talk a lot more about it, but hopefully this episode was useful to your listeners.
[00:46:20] Gopi Rangan: We could spend five hours on this. There's so much more to cover, but we've come to the end of our conversation.
[00:46:26] I have one last question. I want to learn more about your community involvement. Is there a nonprofit organization you're passionate about? Which one?
[00:46:34] David Zhou: There's an organization called Friends of Children with Special Needs. It's local to the Bay Area. They do a lot of good work for people who are on the spectrum.
[00:46:43] I have certain family members that are on the spectrum, and so for many reasons it's been something I've been involved in since middle school. So it's been a while. It's a good reminder that I should spend more time with them, but given my recent schedule, I haven't spent as much time as I used to.
[00:46:58] But I think they're doing a [00:47:00] lot of good work in helping upskill people who are neurodivergent, and empowering them, because everyone tells them, "Oh, you're different. You can't do these things." And the family member I'm thinking of, as they were growing up, they had a lot of, "Oh, you can't do this. Don't even bother. You're not normal. Don't even bother." And I think they're doing a lot of good work in helping people, human beings who spike in very different ways from the rest of us realize their passions and do their best work.
[00:47:27] Gopi Rangan: David, thank you very much for spending time with me. Thank you for sharing deeply insightful thoughts and opinions on how the VC ecosystem, the LPC ecosystem is evolving.
[00:47:38] These are things that we don't really get to learn by reading newspapers or watching the news videos. You really have to talk to a practitioner. Thank you very much for sharing all your knowledge and wisdom. I wish we could spend a lot more time. Maybe we'll do it again in another podcast. But I look forward to sharing your nuggets of wisdom with the world.
[00:47:58] David Zhou: Thanks for having me.
[00:47:59] Gopi Rangan: Thank you, David.
[00:47:59] [00:48:00] Thank you for listening to The Sure Shot Entrepreneur. I hope you enjoyed listening to real-life stories about early believers supporting ambitious entrepreneurs. Please subscribe to the podcast and post a review. Your comments will help other entrepreneurs find this podcast. I look forward to catching you at the next episode.
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