20VC CapitalG Founder David Lawee on Why People Overvalue Diversification in Venture, Why Investment Clubs Are More Successful Than Investment Partnerships & How Growth Funds Think About Portfolio Construction, Loss Ratio & Reserves

In this episode of "20 minutes VC," host Harry Stebbings interviews David Lowey, the founder of CapitalG, Alphabet's independent growth fund. Lowey shares insights from his journey, starting as a serial entrepreneur and later joining Google, where he significantly contributed to its growth through over 100 acquisitions. In 2013, he founded CapitalG with Alphabet as the sole LP, focusing on growth equity investments in high-potential startups like Airbnb and Lyft. Lowey discusses the importance of being contrarian, the challenges of managing a high-performing team, and the necessity of diversity in venture capital. He emphasizes the significance of understanding market timing ("why now") for investments and maintaining a strong investment thesis. Lowey also touches on the unique decision-making process within CapitalG, which operates more like an investment club, where individuals make investment decisions supported by the group, rather than by committee consensus.

• Harry Stebbings introduces the episode of "20 minutes VC" and expresses admiration for the guest, David Lawee.
• David Lawee is the founder of CapitalG, Alphabet's independent growth fund.
• Lawee's experience includes roles at Google and as a serial entrepreneur.
• Thanks are given to Eli Gill, Gene France, and Leila Sturdy for question suggestions.
• Promotional mentions include HelloSign, Draper Esprit, and Secureframe.

This is the 20 minutes VC with me, Harry Stebbings, and what a show we have in store for you today. I'm such an admirer of the incredible institution this individual has built, and so I'm delighted to welcome David Lowey to.

This quote is Harry Stebbing's introduction to the podcast episode and his expression of excitement about having David Lawee as a guest.

• David Lawee founded CapitalG in 2013 using his experience from Google and as an entrepreneur.
• Lawee's role at Google included Chief Marketing Officer and VP of Corporate Development, overseeing 100 acquisitions.
• He discusses his journey from being a serial entrepreneur to joining Google for a green card.
• Lawee's decision to start CapitalG within Alphabet was influenced by a conversation with Larry Page.

David founded Capital G Alphabet's independent growth Fund in 2013, drawing on his experience both at Google and as a serial entrepreneur. Since then, he's helped transform high potential startups into some of the most highly valued businesses of our generation.

This quote summarizes David Lawee's achievements and the establishment of CapitalG, highlighting his influence on successful startups.

• Lawee discusses the challenges entrepreneurs face during market fluctuations, such as adjusting to capital availability.
• He contrasts the entrepreneurial experience with the investor's perspective on market cycles.
• Lawee mentions the difficulty of operating in markets like India, where capital flow is inconsistent.
• He believes that experience with market cycles can lead to a more risk-averse approach, which may be a disadvantage during bull markets.

As an entrepreneur, it's super challenging to manage businesses where the environment is changing so meaningfully around you.

This quote reflects on the difficulties entrepreneurs face during rapidly changing market conditions and the need to adapt to survive.

• David Lawee advises new investors to be aware that they will not make equal amounts of money throughout different market cycles.
• He suggests that investors should look for good opportunities across sectors and countries regardless of the market state.
• Lawee shares his personal feeling of being at a disadvantage during prolonged bull markets due to his conservative mindset shaped by past cycles.
• He acknowledges that a conservative approach may eventually prove beneficial, despite the prolonged period of high valuations since 2013.

I think people are kind of a little bit more cavalier and say, "oh, I invest through the cycle and you're not going to make money. You're paid to put money to work and you're not going to make equal amounts of money in all parts of the cycle."

This quote offers advice to investors about the reality of investing through various market cycles and the importance of maintaining investment activity despite the changing conditions.

• Current market conditions are considered "frothy," indicating potential overvaluation.
• Capital G does not focus on temporal diversification; instead, they prioritize making money consistently every year.
• The goal is to find equally good investments throughout various market cycles, challenging the idea that investment opportunities are uniformly distributed over time.
• Capital G makes fewer investments, aiming not to reflect market averages but to be selective and strategic.

"kind of getting really frothy. Really frothy, really frothy. And that's in a sense, been negative."

This quote describes the current market conditions as being inflated or overvalued, which is generally seen as a negative trend for investors.

• Different markets have varying levels of price sensitivity; for example, enterprise SaaS businesses are currently highly priced.
• Capital G may take different kinds of risks, such as going earlier into investments to avoid overpaying at high valuations.
• The firm casts a wider net overall, looking beyond just highly valued sectors.
• Growth investors are more affected by frothy public markets than venture investors because they're underwriting for higher returns and high entry prices can be detrimental.

"Well, like I said, it differs by market. So today, the SaaS, enterprise SaaS businesses are priced to the moon on average, and kind of a lot of other businesses are not."

This quote highlights the disparity in valuation across different sectors, with enterprise SaaS businesses being particularly overvalued at the time of the conversation.

• Capital G employs an individualistic investment decision-making process, akin to an investment club rather than a collective decision-making body.
• This approach is based on the observation that investment clubs often have better returns than traditional investment firms.
• The culture within the firm encourages individual risk-taking with support from the group, rather than group consensus driving decisions.
• The decision-making structure is designed to minimize politics and focus on the merits of each investment.

"At the core of it is kind of the decision process, and for us, which is extremely unusual for a growth equity fund, we make the investments individually."

This quote explains the unique decision-making process at Capital G, emphasizing individual responsibility over collective agreement.

• The firm's culture promotes independent thinking; the opinions of the group are not necessarily seen as validating an individual's decision.
• Investments are inherently contrarian, as they involve making choices others are not.
• The structure aims to encourage team members to take risks and contribute meaningfully to discussions, altering the dynamic of meetings from consensus-seeking to information-sharing.

"I don't really care what the group thinks, because in the end, I need to make the decision, and I tell that to my team."

This quote underscores the importance of individual decision-making in the firm's culture, regardless of the group's consensus.

• The decision-making structure has consistently focused on independent decision-making.
• Over time, the firm has sought ways to encourage more risk-taking, especially in theoretical discussions lacking detailed company knowledge.
• The ongoing challenge is to balance risk with informed decision-making.

"It's always been the case that we kind of have organized ourselves to make decisions independently."

This quote reaffirms the long-standing practice of individual decision-making within the firm and the continuous effort to optimize this process.

• Capital G started with a growth strategy due to a belief in their differentiated perspective and ability to leverage Alphabet's resources.
• The firm's process for identifying investments is methodical and can involve extensive research over long periods.
• They have a specific focus on growth stages, contrasting with the trend of firms investing across all stages.
• The growth investment rounds are highly competitive, and Capital G competes by being thoroughly prepared and patient.

"Well, I mean, we started with growth because we thought we would have a very differentiated perspective on that and be able to help companies in a unique way by leveraging a lot of the people at Alphabet."

This quote explains the strategic choice to focus on growth-stage investments, leveraging the unique resources and perspectives of Alphabet to support companies.

• Growth equity investment requires meticulous attention and focus.
• It involves being prepared with a thesis, understanding the price to invest, and being able to activate diligence quickly.
• Growth investors must have an outside-in view to be effective.

"So in order to be good at the growth side, it just, it takes all of our attention and focus."

This quote emphasizes the need for dedicated focus in growth equity investment, highlighting the importance of being well-prepared and having a comprehensive understanding of the investment landscape.

• The best time to invest from a valuation standpoint might have been in the past (e.g., 2013), but innovation continues to create new opportunities.
• Covid-19 and work from home trends have sparked innovation in consumer expectations and enterprise needs.
• Growth investors seek extraordinary growth, which is facilitated by market changes.

"But from an innovation standpoint, I'd say during the seven years, we've gone through different waves, and I think now Covid and work from home is sparking a whole new kind of innovation in terms of consumer expectations and enterprises needs to kind of facilitate a global workforce or a remote workforce."

This quote discusses how current events, like the Covid-19 pandemic, have spurred innovation that growth investors can capitalize on, especially in the consumer and enterprise sectors.

• Investor mindset has shifted towards focusing on the "why now" for market takeoffs.
• Growth investors need to believe in higher compounding growth and market expansion than others.
• Understanding the tipping point for technologies like crypto and VR is crucial for investment success.

"I'd say we're kind of much more focused on why now. In our kind of assessment of when markets are going to take off."

This quote highlights the importance of timing in growth investment and the need for investors to identify the reasons behind why a market or technology will grow significantly at a particular moment.

• The goal is to achieve strong internal rate of return (IRR) similar to venture funds, but with a different distribution across investments.
• Growth equity funds aim for fewer losses and a mix of moderate and high returns, averaging to a target IRR.

"So it's kind of more twos and tens. So you're hoping to average to, let's say, 25 30% IRR."

This quote explains the expected return profile for growth equity investments, with a range of outcomes that average out to a target IRR, differentiating it from the venture capital model.

• There is a belief that the value of diversification diminishes after a certain number of investments.
• Growth equity funds may not need as many investments to achieve adequate diversification compared to other investment categories.

"I think people overvalue perceived diversification. I think you get a diminishing return in our business once you get past five or six investments."

This quote challenges the common belief in the importance of diversification, suggesting that after a certain point, additional investments do not significantly reduce risk.

• CapitalG has a unique limited partner (LP) structure with Alphabet, allowing for a discrete approach to each investment decision.
• Diversification is considered from Alphabet's perspective, leading to a preference for concentration over spreading investments too thinly.

"We don't really need to think about reserves because we have one lp. So in every fund we have the same lp, and so we can just think about every decision discreetly."

This quote explains how having a single LP simplifies the reserve strategy and investment decision-making process for CapitalG, making it distinct from other funds with multiple LPs.

• Generational transition is considered important and is addressed from the beginning of a fund's life.
• Alphabet's experience in company building provides resources for addressing issues like diversity and succession planning.

"People were asking me, who's my successor? From the beginning, so I didn't feel that it's something I'd kind of need to think of all of a sudden. I've always been thinking about that."

This quote reveals the proactive approach to succession planning within CapitalG, influenced by Alphabet's broader experience with organizational development.

• Board membership style is adaptive and varies based on the needs of different management teams.
• Building personal relationships with CEOs and understanding how to influence them is key.

"It changes all the time. I think what I've realized increasingly is that different management teams need to be influenced in different ways."

This quote reflects the dynamic nature of board membership and the importance of tailoring one's approach to the specific needs and decision-making styles of the management teams of portfolio companies.

• Understanding the reality of companies is crucial for board members to have a significant influence.
• Board members should be actively engaged and well-tuned with the company's situation to provide meaningful assistance.
• Being disconnected limits the ability to influence and help the company effectively.

The goal is to be tuned to a pretty phenomenal company and try and help them. And that is an extremely hard thing to do.

This quote highlights the importance of a board member's deep understanding and connection with the company to offer valuable help.

• It's ineffective to directly tell people what to do, especially as a minority investor.
• Better to act as a mirror, reflecting the company's actions and helping them focus on the right questions.
• Use past experiences to guide and improve future decision-making without being overly critical.

I find it's not very effective to tell people what to do. As a minority investor, I'd say it's a lot better to try and get them to see you as a mirror and be an honest reflection of what they're saying and help them think about whether they're focused on the right question.

This quote advises new board members to facilitate self-reflection and strategic thinking in company leaders rather than giving direct orders.

• The format involves a short statement followed by immediate thoughts in 60 seconds or less.
• Provides a quick insight into personal preferences and professional opinions.

I'd love to dive into a quick fire answer. I say a short statement and then you give me your immediate thoughts in about 60 seconds or less.

The host introduces a segment designed to elicit quick, candid responses, revealing personal and professional insights from the guest.

• Trevor Noah's "Born a Crime" was a timely read that provided insight into life in South Africa.
• The book was a favorite for the summer, resonating with the current social climate.

This summer I read Trevor Noah's born a crime. I don't know if it's my favorite book of all time, but I kind of read it in May and it was super timely to kind of tune into those issues and kind of understand his life growing up in South Africa.

David Lawee appreciates "Born a Crime" for its relevance and the understanding it offers regarding social issues and Trevor Noah's upbringing.

• Measuring team performance over the correct timeframe is a significant challenge.
• Decisions about personnel need to be made with a long-term perspective, balancing the need for immediate and future success.

It's challenging to figure out what the right time is over which to measure performance.

David Lawee discusses the difficulty of determining the appropriate period for evaluating team performance in a venture capital firm.

• Success involves being involved with innovative and impactful companies.
• Working with exceptional entrepreneurs is thrilling.
• Strong returns are a byproduct and the primary measure of success.

We really want to be involved in some of the most consequential companies in terms of impact and innovation.

David Lawee defines success as the ability to work with companies that are significant in terms of their impact and innovation.

• There is a need for more diversity in thought and demographics within the venture capital industry.
• The current state is too homogeneous, affecting decision-making and the entrepreneurial ecosystem negatively.

Diversity. Diversity of thinking, diversity of people. It's incredibly clubby and white, male oriented, and I don't think that's helping the entrepreneurial world.

David Lawee calls for increased diversity in the venture world, highlighting its current lack and the negative impact on entrepreneurship.

• Working with Ben Horowitz was notable due to his detailed understanding of business operations.
• Such nuanced knowledge is beneficial in advising CEOs and addressing their specific challenges.

I was always struck with how much detail he has around the functionings of a business.

David Lawee praises Ben Horowitz's detailed knowledge, which is valuable for providing nuanced advice to CEOs.

• Albert, a fintech firm, was a recent investment.
• The automation of financial decisions for Americans was a compelling aspect of the investment.
• The potential to improve lives by automating finances and reducing unnecessary fees was a key motivator.

We invested in Albert, which is a fintech firm. And I think for us, in that case, what was exciting was that the finance problems for americans can be automated, and kind of, a lot of decisions don't need to be decisions.

David Lawee explains the rationale behind investing in Albert, emphasizing the impact of automating financial decisions to improve lives.

• Thanks to David Lawee for participating in the podcast.
• Promotion of Instagram for behind-the-scenes content.
• Mention of HelloSign's success and acquisition by Dropbox.
• Draper Esprit's role in investing in high-growth European tech companies.
• Secureframe's solutions for SOC 2 compliance.

I do want to say huge. Thank you, David, for taking the time today, it really did mean a lot.

Harry Stebbings expresses gratitude to David Lawee for joining the podcast and contributing to the discussion.