From the Other Side: What Sapphire Partners Wishes More VC Managers Knew Featuring Nate Leung

Welcome to Swimming with Allocators. I'm Ernest Sweat and each episode, Alexa Bins and I give you a VC podcast from the LP perspective. You ready? Let's dive in. Today, we are speaking with Nate Liang, partner at Sapphire Partners. Sapphire Partners is a limited partner with over one billion in investments in elite early-stage venture capital funds across the US, Europe, and Israel. Sapphire also is the engine-driving #OpenLP. Our guest, Nate, has been every sea creature in the venture food chain operating at Optimizely, investing at Bain Capital Ventures and allocating at industry ventures. Nate, you have always been so generous with your guidance and introductions. It's a real pleasure to be able to share this time with you. Thank you. Thank you for having me. Nate, from your experience on the venture side at Bain and then industry and now Sapphire, what are some of the key learnings that you've received or favorite stories that have really shaped how you look at the asset class today? I'm not going to say the number, probably the same amount of years I've been in industry a little less, but it's been a wild ride. What have you taken away and what keeps you sharp on the industry today? Yeah, I think it's almost a core principle or just a, it's a people business. It's a relationship business and this is a, it's a repeated game, so to speak. So it really matters how you treat people and how you develop relationships, I think. And I think that's been just a thread that's gone from each step in my career at least and helping shape kind of where I think the opportunity set is going forward too. And what I mean by that is I think by being a long-term partner and going through sort of cycles and being able to be a sort of consistent investor through cycles creates opportunity to kind of do more with the folks you're partnered with. And I think that's really exciting, especially like going through macro challenges and things like that. Could you give us the story behind Sapphire partners? When I think of LPs that are leading the charge and thought leadership and trying to kind of raise the bar for the entire allocator stakeholder group, I think of you all. But could you tell the kind of the story from when it started to what it does now? Yeah, actually, I'll start with today and kind of jump backwards. Today, we're an $11 billion venture capital asset manager investing in both funds and companies. And that is actually what we had been doing when we started about 12 years ago now. And even before that, the team that's before my time here at Sapphire, the team had spun out of SAP ventures and became independent, became Sapphire ventures. And when we launched, had both a direct investment strategy as well as a fund investment capability. And from the beginning on the fund side, we've been seeking exceptional venture fund managers focused on early stage, both established as well as emerging. And that's sort of the thread for our investment strategy that's been very consistent. We've consistently wanted to partner with the very best GPs. And that's both new and established. And you recently announced you're launching a new emerging managers program with a big time solo LP, CalSTRS. Yeah, that's the big change. Actually, this year is, is that on our funds platform, we added we added dedicated capital for emerging managers defined as funds one through three, which we had previously been, you know, active, fairly active in partnering with, you know, new and upcoming GPs. But it was always out of one pool of capital. And what, you know, what we did in partnership with CalSTRS, we announced this fall, was to segment that out as a dedicated program, you know, entirely funded by CalSTRS. And, and yeah, I think that, you know, especially in this time, there's a, there's a tremendous opportunity set that we're excited about pursuing together. And maybe I'll take a step back and talk a little bit about CalSTRS and sort of the origin of this partnership. CalSTRS had been investing in venture and backing emerging managers, you know, for over a decade now, too, they've been very active, great long term partners in the ecosystem. And, you know, that said, they've been kind of doing it, you know, broad based in private equity in general. And as we, as we had conversations and developed the relationship, we shifted that program to really focus on venture. And that ended up being a really good fit for both what we were, what both groups were trying to accomplish in terms of backing and finding and backing the next generation of great managers. Is there anything else that's helpful on this platform? We have a lot of emerging managers listening that you'd love to clarify or that they should know about this new program. Yeah, I think, well, I think the most important thing and the reason why we did it is frankly the mission of serving the teachers of California was really compelling for us, both from what the mission stands for, as well as the institutional quality of CalSTRS as a partner. There is as institutional as it gets, right? Over 300, 300 billion in assets, been investing in private equity for decades, partnered with some of the very best GPs, you know, since they're very early, the earliest days. And, and so we saw this partnership as a way to accelerate kind of both of what we were doing. And, and, and the mission was really, really compelling for us to support. And, you know, for the emerging managers out there, that is the mission that, you know, this capital supports, too. So one question I wanted to ask is, given that you guys have experience with emerging managers, as well as kind of established fund managers, you know, how do you, you know, the criteria for both is, I would assume, be different. Can you provide some kind of insight on kind of how you judge or, you know, how you diligence both, whether they be new opportunity or follow up? Absolutely. A great question. And you're right that they're different. But our process isn't much different, if that makes sense. Yeah. You know, what's different is the track record, right? Like the, you know, the amount of time, and maybe just the typically when we've been partnered with a group, there's, you know, we've seen the consistency of a certain strategy play out and, you know, with a, with a new relationship and a new partnership, you just don't have that sort of working relationship. So the, you know, the key difference, I would say is probably around the kind of data that, you know, you can look at and rely on versus the more qualitative kind of analysis. And then, you know, a history of partnership, like years or fun cycles of a partnership is a different consideration than sort of a brand new relationship, right? And so what I think is very helpful, and maybe this is sort of a pin in the advice for emerging managers is how to develop an authentic working relationship, you know, before you're sort of officially partnered, you know, in a fund, like whether, whether you're raising your first fund or second fund and thinking about, you know, cultivating new relationships, a tool that I've found really helpful. And this kind of goes back to my industry ventures days and frankly, my main capital days where co-investments were a great way to partner with, you know, with potential LPs or with these and also with existing LPs. You know, I remember one of the investments that one of the earliest investments I did at Bain Capital was it was investment that we were leading, but it was a sizable check and we brought in an LP to like join for the diligence meetings. And that, you know, became that those are a large part of industry ventures strategies well, which is to do co-investments and partnership with GPs. And, you know, now, particularly in this market where capital is more scarce and where opportunities and valuations feel more, you know, either more logical or more stable, more market can be attractive and a great way to, you know, get to know how to work with an LP and work alongside them, have them see your diligence, experience your diligence, you know, firsthand, which I think is really exciting and a great way to build a relationship. Yeah. And then for the established funds, you know, it's my assumption and what I'm hearing in the market is that, you know, we, a lot of firms expanded scope significantly during this low interest rate environment. You know, we had very high prices and valuations and a lot of those companies, I think the latest data I saw is there's about 100 and, no, sorry, 1200 unicorns and usually only about 20 tech companies go IPO every year. I mean, on average over the last, I guess, 20 years. And so, or maybe that's at most, but whatever the fact is, like, there's a huge bottleneck, right? And so, when it comes to allocators and their, and them diligently and their relationships with established firms, what are even just like, you can say detailed, high level thoughts, how do you, you know, take that into account when people could be at a point of like, had a lot of success and plateauing and not being relevant anymore? A very good question and sort of a lot to unpack. You know, I'll start with the, I'll start with at the sort of portfolio and company level. I think we try to get as much information as we can on actual company performance and really understand, you know, are like, how, how real are the fundamentals around the value drivers? How real are those valuations? And there are two, I think there's several layers to it, but the, the ones that sort of stick out to me are, you know, what are the things that are actually measurable, you know, around revenue, profit, you know, capital raise, preference, capital, capital structure and capital stack. And then how does the GP talk about them? Right? Or how's it presented? Right? And like, are, are things held at the last round valuations? Are things, or are things, you know, sort of adjusted for might be appropriate today? And how do they discuss, you know, the, the, like the, the sort of current state of the investment and what's that sort of, you know, level of communication and transparency? It's like, frankly, what can you really trust? And there's, there's, you know, variation on both sides of that, right? But hopefully, like the fundamentals stuff, like it's like, you know, numbers are numbers. And hopefully there's some truth behind that. And not like, you know, not like accounting irregularities. But then, but then how the partner, you know, sort of discusses that information and shares that information is, is really important in terms of how we think about underwriting. And then we, you know, we try to bring it full circle really with the references that we do, you know, through the ecosystem with founders, you know, co-investors, and really try to assess, you know, the, you know, how close the existing body of investment work really informs the go forward investment strategy. And at the time we're recording this, and they don't have the response, but like we had a pretty big firm that just decided to go bye-bye. So I'm sure it's making the assessment of firms very tough for allocators today. It's absolutely. And those are sort of the issues that are particularly challenging to get under, right? The partnership dynamics, the individual motivations, right? And, you know, there's only so much that LPAs, economics, GP, you know, GP commitments and things like that, you know, only so far that they can go. Yeah. I think it's been a really interesting time. And, you know, certainly unfortunate, but I feel like this is also, you know, there's probably more to come. Yeah. But I think that also creates the space for the next generation of really great firms and managers. Is there anything in those re-up conversations that you can sort of shine light on what you're thinking about? Yeah. So in, I think this is, I'll step back and discuss maybe a little more about our process. Actually, whether new or re-up, we try to spend as much time as we can with the broader investment team, you know, in general, to really like assess some of these dynamics. And, you know, sometimes certain team dynamics are more called obvious risk factors, right? Like a team that's never worked together or never invested together before might be different, right, than a team that had been, you know, making investment decisions together for a decade, right? And so, you know, certain times like those issues are more important. And then, you know, on the other side of this, like where, particularly with established managers, where the, you know, there is a question of sort of transition of economics and frankly, even like transition of sort of investment decision making, like it's a process, right? It doesn't, you know, it doesn't just happen sort of overnight. And I think one of the trends that we've been observing is sort of a bifurcation in the market of like, you know, very large brands or large platforms, large firms versus specialization, right? Specialization by, you know, vertical or stage or what have you. And maybe like a horizontal trend, you know, kind of across both is actually the importance of an individual brand, right? Meaning like an individual GP or investor kind of brand, like what they stand for and that person being the go-to person, right, for referral or for inbound or whatnot. And those two kind of overarching trends I think are driving a lot of sort of the changes of what we're seeing in the ecosystem in that chair. Yeah. Are you seeing them on your allocator colleagues as well? That's a great question. You know, it's anecdotal at best. But I think that is true too. I think there are more, there's increasing specialization in terms of allocators. I'm not talking about like, you know, when like long-standing endowments or pensions sort of shift their kind of staffing model. I mean, like just where capital is kind of going and where talent is going. It feels like there is also increasing specialization, which is interesting, whether it be sort of by asset class, by, you know, transaction or even, you know, firms kind of pursuing like different strategies for like exposure to a space. I'm sure we'll get into secondaries, for example, but that's definitely been an area of tremendous growth and change. Yeah. I wanted to actually, since you teed it up, love to talk about secondaries, given just all the fluctuation in the market and, you know, some emerging managers looking for liquidity in interesting ways or some of their, let's say, newer allocators to the space looking for liquidity. It's been something that we've seen from the fund level as well as at the individual portfolio company level as well. So you've had experience from, you know, your time at industry. What kind of guidance are you giving to, what you give to other allocators and LPs on secondaries? Yeah. I'll take a step back and just think about like the overall market context, which is we've gone from a period of relative tremendous liquidity, right? Like in, you know, sort of the peak sort of periods, right? Like in 2020, 2021, sort of like you would see secondaries trade at a, you know, at par or at premiums, right? Like it felt like there was a lot of liquidity in the ecosystem and very quickly that liquidity evaporated it. And I think where we are now is a bit in a normalization sort of period of like, you know, I think liquidity is going to you for a longer period become, be harder to come by. And that is still largely working its way through the ecosystem. That said, you know, over the past cycle, like there's never been more capital raised into secondary vehicles, right? Like this is across alternative assets and, you know, private assets, like there are $20 billion or larger secondary funds. And, you know, that is more in buyout and private equity for sure. But there's also never been more capital, you know, chasing venture and growth and technology assets too. So like the ecosystem has kind of changed, you know, tremendously. And in terms of, you know, I think advice for LPs, I think I would, I would have conversations and just, you know, assess what sort of the, the kind of options are out there, you know, talk to folks in the ecosystem and really think about like what your long-term strategy is. Frankly, like I would, I think about like, what is your, from first principles, your long-term strategy, like what are the kinds of managers you want to partner with? How do you want your portfolio to be constructed going into the next cycle, right? And if it makes sense to change, you know, what's in your current portfolio in order to accommodate what makes sense in terms of like the, you know, your go-forward portfolio construction and investment strategy, then I think, you know, secondaries are a great tool to really think about that and to really be able to like, you know, take liquidity or reallocate, you know, from, from either certain asset classes or from, you know, certain even specific investments. Is there anything else about secondaries that you feel like people are getting wrong? Yeah, I think there's still, I think there's still a perception. And if this is, so there's, there's variability on both ends in the ecosystem. I think there's still a perception that it's, it's still a bit of a gray area, dirty word, right? Like it's still like emerging as a, a, you know, an appropriate like liquidity solution, but that's exactly what it is. It's a solution, right? So like, and this is where I think there's going to be more sort of creative structuring and, and, you know, more, more players, frankly, in the space. You know, we've, like we've seen a tremendous respect for the, the team and industry, for example, they've grown a lot, right? Like the latest secondary fund is a billion four, I think. And when I was there not too long ago, it was, you know, half that or smaller. And so that's just, it's different. The, but, but, but I think the overall ecosystem is, is moving in a direction where, you know, I think hopefully liquidity and liquidity solutions will be more kind of common place or more, more widely accepted and adopted. And, and I think that, you know, on the other side of that, like there's been a lot of hype, right? In the, and I think there, there's, there's, there's been a lot of hype around secondaries being, you know, kind of cyclical, right? Or like being able to find incredible assets for cheap. Like the reality is most folks aren't selling their incredible assets, period, let alone for massive discounts, right? And so the perception that there's all this value to be had just hasn't been, frankly, really been unlocked yet. But I think as expectations on buying sell sides start to converge more, that I think, I think the overall market and, and, you know, the velocity of the market will start to pick up. You've been quoted as saying, I love being an allocator. So just as somebody who's been both a VC and now an allocator, what's something that you've learned being on both sides? Or what are some of the misconceptions that when you were VC that you wish you would have known about allocator? I think about, and this kind of goes back to, you know, the, the one of the, the principles kind of throughout my career, which is in the ecosystem, you know, investments are not transactions. They're partnerships. And therefore, you know, bringing like closing an LP is not a sale. It's, it's the beginning of relationship actually, right? It's a proposal. That's right. That's right. This is like the, this is the start, you know, of the marriage long-term partnership. And, and I think it's, it's, it's really important to kind of keep that in mind. Because I think, you know, when things were a lot easier and in the prior cycle, right, like everyone was moving fast and not doing as much work and deep thinking as should have taken. And I think, you know, personally I'm guilty of this, right? So, so definitely. But I'm excited about going forward, deepening relationships, and, and also building new ones and supporting, you know, new folks, getting into venture as well. I think authenticity is also kind of a misunderstood thing in venture, right? I mean, I could, because I think there's a tension so much of what happens or what drives activity can be around brand, right? And around heat and around hype. Because you're thinking about the future, right? You're thinking, like, there's a lot of discussion about potential. And, and I think, you know, it's, it's maybe a human condition, but we can get kind of carried away. And so the like truth and authenticity, I think, gets, gets sometimes undervalued. And then, and I also think this goes a little bit back to the secondaries sort of conversation, but I think duration of venture investments is also misunderstood, right? Like we've anchored around a 10 year like fun life, you know, with two year extensions or whatever, right? But like the reality is things change maybe in a shorter period than expected, or like maybe it takes longer, like a lot of times, you know, things take a lot longer than, than 12 years to really realize value. And like, you know, I think different LPs, different allocators have different time horizons, right? And I think, you know, same thing with, with, with GPs, I think folks have different expectations, like, you know, frankly, I've been, you know, in this business as an, as an LP for eight years, and that's not even like, that's not even close to a full cycle yet. Yeah, yeah, you don't know if you're good yet. You're like, the data's still out, it's still on paper. Now we're going to take a quick break to speak with our sponsor. On the show today, we have industry expert and sponsor, one of my all time favorite founders, John Lange, co-founder and CEO of Canopy. Canopy streamlines the administrative process, think legal wires, taxes, etc. for private equity, co-investments and SPV. Thank you, John, for partnering on the show. A lot of the LPs who come on the show are particularly interested in co-investment opportunities. In many, in many cases, they're investing with emerging managers with, with the intention of putting more money to work in, in, in SPVs, like, like what you're setting up. Any, any trends you're seeing in the co-investment space, too, that, that might be interesting or a takeaway for the audience? Yeah, I mean, I think to reiterate your point, I do think, you know, institutional LPs are thinking a lot about, like, why are we paying such expensive fees, right, to these like large funds? Like, how do we get more direct access? I think, you know, as you talk to a lot of these institutional LPs, I think, you know, that'll be a big theme, right? Everyone's like, Oh, how do we get more direct access? And I think, you know, from the GPs perspective, they aren't like against it, right? But it's just a lot of work. I think both on like the legal component, right, getting like the financials, right, flow of funds, components set up, etc. Like, I think if they had a really easy way to do it, I think they would be willing to, because at the end of the day, you know, for them, it's, it's not necessarily like free carry, but like, if you are under the sort of assumption that, you know, we're investing in a really, really good company, it's definitely going to go up, then actually, you sort of can't think about it that way, because the alternative is like, what you can't write it from your fund, right? So you'll probably end up just like introducing the LP to the portfolio company as like a gesture of goodwill. But if you were to set up something that's just like, Hey, 10% carry, like, you know, maybe like very, very low management fees, like people would just be like, Oh, okay, you know, that kind of makes sense. And actually, you can just pull more capital from your LPs. I think a lot of the times, maybe people are a little bit too aggressive, I think on their numbers, I think if you talk to institutional LPs, they've probably give you the same feedback, we're like, why am I paying like two and 20 on like a co investment vehicle, like that doesn't make that much sense. So I think like, you know, people are just, Hey, it's really easy, it's not that expensive, you know, we get a little bit of money, but like, obviously, the alternative is you get none of it. Like, I think that calculus is that super complicated to make. Yeah. Do you see the carry? Are you seeing more an average go to it? It's carry now closer to 10%. I don't think it's necessarily close. I mean, I guess it depends on how you think about our clients and our sort of like the deals that types of deals that we do, right? So I think like, actually, we have customers who come on and do like 0% carry, actually, because I think from the portfolio company's perspective, they were like, okay, we want one check, we don't want a bunch of introductions to your LPs, like just tell us how much like you're able to do. And it sort of ends up functioning as like a gesture of good will, right? Like these LPs will pay for our fees, right? Like just like the entire process. But at the end of the day, they keep all the upside. I think like 10% is a fairly standard number when you think about, you know, large scale co investments. Obviously, there are still people who charge 20. There are people who do side letters, right? I think our system is capable of like very easily configuring and automatically generating like side letters for folks as well. But yeah, I think like to my point earlier, it just makes a lot of sense to not charge that much, to be honest, right? Like, I think everyone wins in the end, and then there's no need to say like, oh, how can I get that like extra dollar, right? And then you sort of like build more good will too, when you like go raise your next fund, people are like, well, actually, yeah, they didn't really charge us carry on that. Maybe we have more opportunities to get exposure to really great companies through, you know, Alexa and her fun, right? Like, I think that's sort of how I would think about it. If I were building a fund, I don't want to fund, obviously, but like, I think that's probably how I would prefer to think about it. Like very long term game, right? At the end of the day, like PCs, let's say 10 year asset class, especially if you're like very, very early stage and you need the late stage capital to like bridge your co investments, right? Or your Parada rather, sorry. Like, because if you have a really large fund, you probably don't care about this, you're probably just like, okay, actually, why do we need to do co investments if we have like a $2 billion fund, right? It's a completely irrelevant question. So I think like, if you're like a really early stage investor, it really is about like, how do you, you know, have a lot of like repeat win-win transactions with your customers? And I think that's how I like about it. Yeah. Yeah, absolutely. John, you clearly are out ahead on the future of venture capital for those interested in using Canopy software to set up funds, manage capital and report performance. You can please visit haycanopy.com/allocators and then Ernest and I get credit for sending you. Thanks so much. And now back to our LP interview. Are there any stories you can share of, you know, building a relationship with somebody over time or what that's been like? I've been really excited and grateful to bring a relationship and a partnership full circle. So I'll start with, the group is Workbench, I'm not sure if you're familiar with them. They're an enterprise fund based in New York. And I had originally worked on a partnership with them at Industry Ventures. This is, you know, one of the, one of my earlier deals. The first one was entirely owned by a corporate. And we helped them restructure it and bought half of it. There are some great assets in there. That fund today is, you know, is north of a 3X, you know, with like great pathway. And so, you know, that transaction was, you know, back in 2017. Right. So like, this is like, I'm really excited about that early return. We also came into fund two as an anchor investor. And I've gotten to, when I left industry and joined Sapphire, continue developing that relationship, you know, from, from a, you know, admittedly a bit more of a distance, but now excited to share that we've come into their most recent fund. But we've come in with a substantial, actually even larger commitment that we wrote at Industry Ventures. And, you know, it's, it's now been seven years in the making that, that this relationship has developed. We've done co-investments together. And I've just gotten to know them as, you know, as people like share kid photos, all that stuff. And it's, it's an amazing, personal and professional kind of relationship. And, you know, I think they're just getting started. Right. So they just, they celebrated their 10-year anniversary. And we're really excited about the coming 10 years or more. Well, thank you. Any, any parting words? Is there anybody that you want actually to reach out? Who, who, what is the criteria of people who are, are the kind of people you'd like to talk to and, and so that, so that they know what you want. Yeah, two things. One is for emerging managers raising their first three funds in the US, you know, we're, we're excited. And, and we have, we actually manage all of the introductions and inbounds through an inbox funds submissions at sapphireventures.com. So it's FUND submissions at sapphireventures.com. And then if any folks, whether they be LPGP, are interested in exploring, you know, secondaries or just, just talking about potential liquidity solutions, I'm, I'm always excited to, to jam on conversations like that. That's awesome. Nate, you are a resource for me in all things. So anybody would be lucky to, to, to pick up this thread. Thank you so much. Thank you. Thanks, Nate. See you later, allocator. After portfolio tile, investing with a smile.