20VC Are VCs Still “Open For Business”, How VCs Attitude To Risk Has Changed & The 2 Most Valuable Assets To Founders Today with Fred Destin, Founding Partner @ Stride VC

In a special episode of the 20 minutes VC, host Harry Stebbings is joined by his best friend and business partner, Fred Destin, founding partner at Stride VC. They delve into the impact of Covid on the investment landscape, discussing how the pandemic has altered the investor mindset and the venture capital market. Destin shares his journey from derivatives at Goldman Sachs to co-founding Stride with Stebbings, highlighting the importance of adapting investment strategies during crises. They examine the necessity for founders to understand VC behavior in recessions, the potential for LP defaults, and the critical nature of maintaining discipline in reserve strategies for portfolios. Destin emphasizes the importance of transparency and honesty in communication between GPs and LPs, as well as the need for venture investors to deeply engage in company building to create value during these challenging times.

• The episode is unique due to the guest, Fred Destin, who is Harry Stebbing's best friend and business partner.
• Fred Destin is a co-founder of Stride VC, one of Europe's newest and largest early-stage seed firms.
• Fred's background includes being a general partner at Accel and a partner at Atlas Venture (now Accomplice).
• Fred's portfolio has a total enterprise value of over $10 billion and has generated more than $700 million in exit value to investors.

"Now, this is a very special episode of the 20 minutes VC for a couple of reasons. First and foremost, it's with my best friend and business partner, Fred Destin."

This quote introduces the special nature of the episode and the significance of Fred Destin as a guest.

• Fred had an unconventional start in venture capital, coming from a background in derivatives at Goldman Sachs.
• He shifted from finance to entrepreneurship, focusing on seed investing.
• Fred found his passion in venture capital and enjoys his work, never feeling like Mondays are a drag.

"Well, I have one of the worst backgrounds of anybody, you know, in venture capital, given that I started doing derivatives."

This quote explains Fred's unique entry into venture capital from a non-traditional background.

• Fred Destin and Harry Stebbings met when Harry was hustling to meet with Fred while he was at Accel.
• They had an electrifying interview and hours of discussion, leading to mutual respect and admiration.
• Both had the idea to start a seed fund, and their partnership in founding Stride VC felt like a moment where the stars aligned.

"And one day, this young man was hustling his way into my office... And that, my friend, was you."

Fred recounts the memorable first meeting with Harry, which eventually led to their partnership.

• Despite the message that venture capital firms are "open for business," the reality has changed due to COVID-19.
• Founders need to understand that VC behavior will change during a recession, with deal volumes expected to drop significantly.

"It's, I believe, extremely unhelpful for founders to go out there with a message that says, we are open for business as usual, because nothing about this is usual."

Fred discusses the misleading nature of claiming business as usual during the COVID-19 pandemic and the expected changes in VC activity.

• The macroeconomic impact of COVID-19 is unpredictable, with no existing models capable of forecasting the crisis's effects.
• The economy is facing simultaneous shocks to trade, globalization, and travel, affecting demand, supply, working capital, and credit.
• Unemployment numbers are unprecedented, and the social fabric has become fragile over the last two decades, exacerbating the crisis.

"We have too many unknowns about anything from testing to potential short term solutions to the realistic time it's going to take to produce vaccine, et cetera."

Fred highlights the numerous uncertainties surrounding the crisis and the inability of models to predict the outcome.

• Governments have learned from past crises and are rolling out stimulus packages aggressively.
• Concerns remain over the long-term effects of quantitative easing (QE) and the lack of traditional levers for government action.
• There is a possibility of inflation returning, complicating the economic situation further.

"So you're effectively reliant almost entirely on governments printing money and effectively throwing away any form of fiscal prudence."

Fred discusses the reliance on government interventions such as QE and the potential risks associated with such actions.

• Stride VC has been explicit about pausing investments during the crisis due to the rapid influx of new information and the dynamic nature of the environment.
• The private market prices do not adjust immediately, and Stride VC believes it is more prudent to wait and observe before making new deals.

"So I have zero doubt that amazing companies will be built through this crisis. And we can see some very clear corridors of opportunity today."

Fred expresses confidence in the potential for strong companies to emerge during the crisis but emphasizes the need for caution in the current volatile environment.

• Venture capitalists are inherently optimistic and believe in the future.
• It takes time for markets to process information and for investors to develop decision-making and risk-taking frameworks during rapid change.
• Founders currently have two valuable assets: cash and time.
• Investors are adjusting to the market by investing more slowly and with higher criteria.
• Investors wish for more transparency about the pace and selectiveness of investment during uncertain times.

"It's true in real estate. I think it is partly true in venture capital, because everybody around the table tends to be optimistic."

This quote highlights the optimistic nature of venture capitalists, emphasizing that it's a common trait in the industry.

"There is another aspect to this, which is founders have two really valuable assets right now. One is cash and the other one is time."

The quote points out the current valuable assets for founders, suggesting that they should be mindful of how they use both during uncertain periods.

• Investors must ingest and comprehend large amounts of data to understand the situation.
• The view of risk evolves in a crisis, with considerations like value at exit, time to exit, and the path to exit.
• Early-stage investors believe each investment should potentially return the fund on its own.
• Time to exit is expected to increase, impacting internal rates of return.
• The path to exit is scrutinized, considering the number of funding rounds needed and potential dilution.
• Investors control variables like cash, pre-money valuations, and terms.
• In uncertain times, investors may ask for a risk premium, similar to insurers covering unusual risks.
• Terms can include unfavorable conditions like participating preferred, full ratchet anti-dilution, or warrants and dividends.
• Founders and investors should be wary of terms that create misalignment and focus on backing the right entrepreneurs for exceptional outcomes.

"So the baseline thinking for most early stage investors, people like us, is every investment that you make should be able on its own to return a fund."

This quote summarizes the fundamental investment approach of early-stage investors, which is to aim for each investment to have the potential to return the entire fund.

"So you bake all that in, you have time, path and absolute exit value. And what are the variables you control today? Essentially it's cash, pre money and terms, and voila."

This quote explains the key variables that investors focus on controlling during a crisis, which are cash, pre-money valuations, and investment terms.

• Term sheets are complex, but core business terms are limited.
• Unacceptable terms include those that can strip founders of equity, such as excessive reverse vesting or bad leaver clauses.
• Full ratchet anti-dilution is particularly harmful as it can dilute founders' equity to zero in a down round.
• Participating preferred terms, which allow investors to double-dip during exits, are objectionable.
• The focus should be on finding investments that can significantly multiply their value, rendering harsh terms unnecessary.

"So the key things you want to look out for are, number one, anything that is designed to screw you out of your equity."

This quote advises founders to be vigilant about terms in investment agreements that could unfairly deprive them of their equity.

"For example, participating preferred. So in a participating preferred, it's a so called double dip."

The quote explains the concept of participating preferred shares and why they can be unfavorable for founders, emphasizing the importance of understanding such terms.

• There is an influx of new funds in the market, with a high number of new funds established in the US over the past decade.
• Limited Partners (LPs) will be more selective in future fundraising, demanding differentiation and a unique value proposition from funds.
• Fast deployment of capital is risky and difficult to recover from; slow and deliberate investment is preferred.
• Temporal diversification is seen as beneficial, especially in anticipation of market downturns.

"There is something in the region of 1100 or 1200 new funds that have been established in the US over the last ten or eleven years or so."

This quote provides a statistic on the growth of new venture funds, indicating a saturated market.

"It is very difficult to invest fast and well. It is even more so in fast."

The quote emphasizes the challenge of investing quickly while maintaining quality, suggesting that a measured approach is preferable.

• First-time fund managers may face difficulties if they've expanded too quickly.
• Rapid expansion can leave managers reliant on capital markets for bailouts.
• There's a risk of being in trouble if the market conditions are unfavorable.

"If you're a first-time fund and you've gone out the gate too fast, which is a classic mistake of first-time managers, which I have a lot of sympathy for, you're probably in a whole heap of trouble."

This quote highlights the vulnerability of first-time fund managers who may have scaled their operations too quickly without establishing a solid foundation, making them susceptible to market downturns.

• Managers must maintain discipline and not allocate funds to the earliest or most demanding investments.
• Decisions must consider potential future returners, not just current portfolio.
• A disciplined approach is critical, especially during chaotic market conditions.

"It is very tempting to say, well, I will support my portfolio no matter what. And effectively, what happens is the first through the gates gets the money. It is, however, not the right decision..."

This quote emphasizes the importance of resisting the urge to indiscriminately support all investments, suggesting that a strategic approach is necessary to optimize the portfolio's performance.

• Fund managers must make tough choices, potentially cutting ties with companies they are emotionally invested in.
• The primary responsibility of fund managers is to generate returns for their investors.
• These difficult decisions are a necessary part of the job, despite the emotional challenges involved.

"It is tough because some of the founders you love dearly, they may have become friends, their teams, and they may still not make the cut. And that is one of the hardest parts about our business."

This quote captures the emotional difficulty of making business decisions that may negatively impact companies and founders that fund managers have grown close to.

• Understanding the perspective of LPs is crucial for effective communication.
• Overcommunication and transparency are key, especially during crises.
• GPs should provide detailed insights into how the crisis affects each company and the portfolio.

"So what you do well, you over communicate without being asked, is step number one."

This quote underscores the importance of proactive communication from GPs to LPs, particularly during times of uncertainty.

• LP defaults are a real possibility, even for top-tier funds.
• Emerging managers may lack leverage to enforce capital calls.
• Demonstrating responsible management and transparency is crucial for maintaining LP confidence.

"But I think it is a factor. It's something that the industry does not talk about very often. But some of the world's best known managers and myself have stories to tell about lps defaulting."

This quote reveals that LP defaults are an industry reality, often not discussed openly, and presents a challenge that fund managers must be prepared to face.

• Emerging managers should be transparent and honest in their communications.
• It's important to manage LP expectations regarding capital calls and fund liquidity.
• Venture capital can be attractive despite its illiquidity, but managers must prove their worth.

"This is not a time to play games. People need valid, accurate and unvarnished information. So even if the facts are bad, give them the facts."

The quote advises managers to be forthright and clear in their communication, especially during economic downturns, as this builds trust and credibility with LPs.

• Fred Destin emphasizes the importance of true passion for one’s work during a crisis.
• He advises emerging managers to focus on company building and in-depth support for founders.
• Suggests practical involvement in product strategy, messaging, branding, and pricing discussions.
• Acknowledges the possibility of failure due to external factors like COVID-19 but stresses the lasting value of the work done with founders.

"My key observation is this crisis in particular, I think will be harder and deeper than you imagine. And this is a time when we're really going to separate, I think the people who have real passion for what they do and the others..."

Fred Destin points out that the current crisis will be challenging and will test the commitment and passion of individuals in the industry.

"What nobody can take away from you, though, is going to do the work with the founders and helping them through tough times. And that will always be your accomplishment and your achievement and will make you stronger and will give you reference ability no matter what the outcome is on the portfolio."

Fred Destin highlights that the effort and support provided to founders during tough times is a valuable experience that contributes to personal growth and reputation, regardless of the financial outcome.

• Fred Destin expresses his admiration for David Lynch, citing his multifaceted talents and impact on Destin’s worldview.
• He shares his appreciation for board member David Frankel, emphasizing his enthusiasm, passion, and constructive approach to board discussions.

"Anything by David Lynch will always find my favorite because David Lynch is a poet and a writer and a painter and a filmmaker."

Fred Destin shares his admiration for David Lynch's diverse artistic talents and the impact his work has had on Destin's perception of various aspects of life.

"And when we funded Pelpac together out of techstars, I found myself with somebody in the room who had a same level of passion as me, who did not hesitate to push back on founders, but in a way that was conducive to dialogue and trust building and not being an asshole."

Fred Destin praises David Frankel for his passion and constructive approach in board meetings, which foster dialogue and trust without being confrontational.

• Fred Destin shares his strategy for dealing with stress and anxiety during the COVID-19 pandemic.
• He advises turning off the news and focusing on positive actions within one's sphere of influence.
• Destin finds personal solace in helping others and suggests that it brings reciprocal benefits.

"The moment I decided that the most valuable thing I could do is to do something good within my sphere of influence... But it started, to be honest with turning off the news."

Fred Destin explains that he found it most valuable to contribute positively within his immediate environment and that distancing himself from constant news updates was a crucial first step.

• Fred Destin appreciates Harry's consistently positive attitude and how it brings joy to their work relationship.

"Harry has taught me, or has brought to me a good level of joy, because he's always in a good freaking mood and with a smile on his face."

Fred Destin acknowledges the positive impact of Harry's cheerful disposition on their professional interactions.

• Fred Destin reflects on the importance of self-reliance and comprehensive learning in venture capital.
• He wishes he had known the necessity of understanding all aspects of the business from the beginning of his career.

"I wish I'd known that nobody will train you, nobody will mentor you in a way that's really meaningful."

Fred Destin shares his realization that meaningful training and mentorship are rare in venture capital, emphasizing the need for self-directed learning.

• Fred Destin discusses his investment in Collective Benefits, a company providing insurance to gig economy workers.
• He finds the mission of Collective Benefits particularly relevant during the COVID-19 crisis.

"Collective Benefits...is trying to innovate in the world of insurance by providing key benefits to either self-employed workers, temporary workers, or so-called gig economy workers."

Fred Destin explains the purpose of his investment in Collective Benefits and its significance in the context of the gig economy, especially during the pandemic.

• Harry and Fred conclude the conversation with an expression of mutual appreciation and a teaser for the next episode.
• They mention Fred's social media presence and encourage listeners to engage with them online.

"My pleasure, Harry. I'll speak to you tomorrow morning."

Fred Destin closes the conversation amicably, indicating a strong working relationship with Harry.