Episode #177: Alex Rubalcava, Stage Venture Partners, “We Want To Help Build Companies That Are Solving Hard Problems That Matter”
Guest: Alex Rubalcava is a General Partner and Co-Founder of Stage Venture Partners. With experience in both public equity and venture capital investing, Alex has been a professional investor since 2002. He started his career as an analyst at Anthem Venture Partners, a leading venture capital firm in Santa Monica. While Alex worked at Anthem, the firm backed startups including TrueCar, Myspace, and Android.
Date Recorded: 7/24/19 | Run-Time: 1:07:47
Summary: Alex and Meb start the conversation by discussing startup company fundraising, and how it has gotten more difficult to attract top-tier VC firms. The two then get into Alex’s firm, the track to seeing over 1500 startups this year, the process of evaluating them, and doing meaningful work on about 75 per year.
Alex shares his thoughts about the current IPO market, and some reasons he thinks it’s not in a bubble right now. Meb then asks about the SaaS business model, and how the world has changed. Alex weighs in with some comments and some ways he thinks about looking at these types of companies.
Next, Alex gives a brief review of QSBS rules, and the potential tax benefits available to investors. The conversation shifts into the current deal environment, and competing for allocations for deals. Alex provides an example of seeing an opportunity and fighting for an allocation. He also describes how his initial optimism about an investment correlates with the results in ensuing years.
Meb then asks Alex about AI and the opportunity there. Alex describes his firm’s bullishness on AI, and why he thinks AI isn’t going to take over as many jobs as we think it will right now. Alex then gets into AI deployment doing one of four things; segmentation, optimization, anomaly detection, and recognizing objects. Commercial AI systems are being built to automate a process or make a prediction about the future.
As the conversation winds down, Alex describes portfolio investments deploying AI to bring new approaches and ideas to their respective industries.
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Links from the Episode:
- 0:50 – Welcome to our guest, Alex Rubalcava
- 2:25 – Challenge with raising Series A
- 4:18 – State of Venture Capital
- 6:12 – Celebrities in angel deals
- 6:15 – The Meb Faber Show Episode #166: Radio Show: Greece and Russia Are Having Monster Years…Geographic Diversification…and Meb’s 401(k)
- 8:47 – Process for making investments
- 11:35 – How the public markets look to Alex
- 13:10 – Profitless IPOs and the nature of going public
- 13:52 – The Meb Faber Show Episode #170: Bill Martin, “On The Short Side, Position Sizing Is The Biggest Driver Of Success”
- 16:53 – SaaS companies in the investment space
- 18:39 – Disparities in IPO’s, as well as between public and private markets
- 22:05 – Qualified Small Business Stocks (QSBS)
- 22:07 – The Meb Faber Show Episode #78: “If You’re Going to Be an Angel Investor… You Have to Be Devoting Significant Time to It”
- 29:04 – Special purpose vehicles as pass-through entities
- 30:14 – Per fund investment rate
- 31:53 – Competitiveness for deals
- 33:20 – How Stage Venture Partners’ initial instincts play out in investments
- 37:18 – Alex’s perspective on AI and the changing workforce
- 46:12 – Implications of AI on investing
- 49:24 – VeriSIM Life
- 54:56 – Getting the value out of proprietary information from a start up
- 56:04 – Placer.ai
- 59:16 – Drone detection investment
- 1:05:10 – Future for Stage Venture Partners
- 1:05:58 – Connecting with Alex: Twitter: @AlexRubalcava, @StageVP, StageVP.com
Transcript of Episode 177:
Welcome Message: Welcome to “The Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com
Meb: Hey podcast listeners, hope you’re enjoying your summer out of the sweltering sun. We’ve got a great show for you. We’re bringing back my friend and our guests from episode number 78. He’s a GP and co-founder of Stage Venture Partners, a seed venture firm focused on emerging software tech for B2B markets. He’s been a pro-investor for, wow, almost two decades no starting his career as an analyst at Anthem, a leading VC firm in Santa Monica, and he also ran a long-short fund for about a decade. Welcome back to the show, Alex Rubalcava.
Alex: Thanks Meb. It’s great to be back.
Meb: So man, what’s going on in the world? You’ve been busy on your third fund now. Congratulations.
Alex: Thank you. It’s very exciting.
Meb: They keep getting bigger and better. What’s the state of VC looking like these days?
Alex: Well, we’re actively investing. We’ve got 23 portfolio companies now in all sorts of areas in enterprise software, everything from e-commerce to artificial intelligence to defence in aerospace. And so we’ve got a lot of really exciting companies and it’s an interesting time in the market. One of the things that we keep hearing is that there’s all this money sloshing around and that there’s lots and lots of people investing and there’s lots of sloppy activity out in the market, and actually we think that’s kind of wrong.
Meb: It’s wrong because there’s never any money sloshing around me. I hear it. This slosh is going on somewhere, but I don’t know where the slosh is, but okay, tell me what’s happening.
Alex: Yeah. People who talk about money sloshing around, I think have probably never raised capital from LPs.
Meb: Or maybe they’re just friends with Epstein. All right, too soon. Let’s go. Keep going.
Alex: Ouch. So one of the things that I think is really interesting in the market right now is how hard it is to raise a Series A. If you look a few years ago, even five, eight years ago, raising a Series A for an enterprise software company meant that you had to get to a million, maybe a million-and-a-half in annual recurring revenue, ARR. And across all the companies that we see today, that’s just not the case anymore. The bar has gotten a lot higher. Right now, you probably have to be doing somewhere between $2 million and $3 million in ARR and growing at 150% annually or more in order to attract a top tier VC to complete your round.
Meb: Now, is part of that because simply the definitions have all shifted down one letter? Is it because seed is now really Series A and Series A is now Series B and whatever it used to be, seed is now called pre-seed or something? I wish there was actually like a monetary almost definition, like look, this market cap, this is what this round is, but I get it. Is there an element of that that more people are in the game?
Alex: Yeah, it’s partially that and so if you look at what a seed round was a decade ago when the institutional seed market really began developing as an asset class, that type of a round was $500,000 raise on like a $2 million or $3 million pre-money valuation, and often that was enough to get you to then a $5 million Series A on $12 million or $15 million or $18 million pre. And now, companies often spend two or three years between formation and raising an A, often for years sometimes. And to get a Series A from a leading venture capital firm, the average amount of money that is raised is around $5 million to $6 million before the Series A.
Meb: What do they spend it all on? That’s a lot of money.
Alex: Hopefully not office parties. Hopefully not snacks.
Meb: So it’s actually not sloshing around as much as you think. You don’t believe it as much, but what’s the general state? Are you seeing tons of opportunity from the standpoint of companies you’ve talked to? Is it a desert, is it an oasis? What’s going on?
Alex: Well, it’s pretty active out there. We are on track to see something on the order of 1,500 startups this year and we will end up investing in somewhere between 7 and 10 in that time period so there’s no shortage out there. One of the interesting things about the seed market that’s a little bit deceptive is that companies don’t really report their seed rounds anymore. If you raise one million bucks from an accelerator or a couple of angel investors and maybe one small VC firm, you’re not generally putting a press release out about it. And the industry newsletters, the pro-rata or the term sheet or the strictly VC email newsletters that go out every day aren’t really reporting on rounds of that size even if they have been documented in filings.
And as a result, it looks like the activity in the seed market is way down. If you look at like year over year numbers for 2019 versus years past, they look down but that’s just because it’s not getting reported. And they often get reported a year or two after the fact as part of a larger round. For example, we have a portfolio company called Sound Commerce up in Seattle that does e-commerce software and they just announced a major round led by a Silicon Valley venture firm and our investment was announced and it was the first time that anybody had ever heard that we invested in that company when, in fact, we actually wrote the first check into that company a year ago.
Meb: I feel like that’s gotta be a little challenging sometimes from y’all’s standpoint because you want to say, “Hey look, look how brilliant we were. This is an amazing company.” I wanna demonstrate just how smart we were to be a part of this, but at the same time, the competition and being stealth is challenging too. Something that’s totally unrelated, as all of our conversations are, we did a recent podcast where we were talking about how Jay-Z just became hip-hop’s first billionaire. And I feel like it’s a little bit of a lazy assessment of the world to look and say, oh my gosh, all these celebrities are now investing in angel deals, in VC, whether it’s athletes like Kevin Durant, whether it’s other celebrities, Ashton Kutcher, local L.A. fellow who had been investing for a long time.
But part of it, I think, is actually…it’s simple to come away with that standpoint like all this dumb money is going in. But once you see the success a lot of these guys have really had and they understand this concept of being an equity owner or if you look at a lot of these celebrities and athletes that end up making it to the billion-dollar-plus list, it’s never because of athletics or music, it’s because of the business side. So Jay-Z’s was like champagne, his streaming music service, stakes in Uber and everything else. I really have no question. It was, as you said, if there’s a lot of money sloshing around, I feel like a lot of people would seem that that would be a sign of it, but it doesn’t really feel like it is.
Alex: It’s an interesting thing. I always think of celebrities and athletes and entertainers investing in this area in like Peter Lynch terms. Peter Lynch always said to invest in what you know, and if Jay-Z were out there trying to invest in cancer immunotherapy startups, that would probably be a bad idea, but he does know something about branding high-end spirits.
Meb: So Dre would be a good example too.
Alex: Yeah, invest in what you know make sense. And that’s something that we have an interesting perspective on as a venture firm based here in L.A. A significant amount of our capital does come from the entertainment industry. We have an NBA all-star, we have a super bowl winner, we have a film producer, we have a DJ, we have a significant singer all as investors in our fund. And many of them see their friends who are out there doing deals directly and have some degree of interest in what they’re doing, but they realize that maybe it’s better to be a passive investor in a fund as opposed to trying to do it yourself. If you’re really gonna do it yourself, you’ve gotta go all-in and do it like Ashton Kutcher did.
Meb: And he, to be clear, doesn’t do it by himself. He’s got a fair amount of counsel and help that is involved in industry as well.
Alex: He has a 14-member team or so at Sound Ventures and I know a number of them and they’re a real pro in the shop. They know what they’re doing.
Meb: Because it’s a full-time job, man. I try to do it as a hobby and it’s a lot. I mean 1,500 companies, how many of those…like what’s even the process? Are the vast majority of those cold inquiries and any of those ever even get past the AOL spam inbox? What’s your process?
Alex: So only a subset are actually cold and over the [inaudible 00:09:00]. Most come from introductions from people we know, from founders that we have already backed, from attorneys and financial professionals and service providers to startups, from accelerators, from angel investors and whatnot. And the funnel is about, we get 1,500 or so in. We will take a meeting or a call with approximately 500 per year. That means more than one a day. Today, I have two on my calendar and my partner, Rob, has one or two. And about 80% of them, we don’t get past the first meeting with. We thank them for coming in and pitching, but it isn’t a fit for us. We do meaningful work on about 75 per year, so right now in our CRM we have 5 that are marked as in-process and in diligence and that leads to then the 7 to 10 that we end up doing.
Meb: Wow. There’s a lot of balls in the air, I imagine, and not on top of that also is still keeping tabs with your current portfolio companies that go on to raise future rounds that you’re still…I think you mentioned you will do a follow on investment if it makes sense.
Alex: That’s correct. And so the looking for startups to invest in and researching them part of the job, it’s only a third. The building the business aspects, of raising LP capital, and then the most important part, which is being there for our portfolio company founders, that’s by far the most important part. We sort of view our investors, our LPs, as our shareholders and we view our founders, the founders of our startups, as our customers. And we believe a lot of companies do that. The way to have good things happen for shareholders is to take a customer-centric approach. We always tell people that we kind of think of ourselves like Costco or Trader Joe’s, you treat your customers well and the shareholders will do well by extension, and that means all sorts of stuff.
And we have a portfolio company that just recently completed a significant seed growth raise, so not quite a Series A but a big important round with some great investors where the raise took six months. In the process, the company became very low on cash. We had to bridge the company along with one of our co-investors. And then when the leads that we had introduced to the company put a term sheet out, the deal went from going nowhere for 5 months to being oversubscribed in about 11 days. And helping to manage that process and to help the founders through fundraising, which can be very confusing and different from anything they’ve ever done before, is a big part of what we do.
Meb: I think as we look around the private space and as we also…you’re a long-term public markets guy. As we look around the public space too, I think people would say, you know what, Alex, it seems like things are getting a little frothy in the public markets. We’re romping and stomping this year, market’s up 20 plus. We’re recording this late July, so depending on when this comes out, Beyond Meat, it up above $12 billion valuation. A lot of people look at these many indicators of what’s going on in public markets, particularly in tech, and they say…pull their hair out and gnash their teeth and say, “This is a bubble.” Is that what it looks like to you? What’s your takeaway on what’s going on and sorta your world on the public side?
Alex: Yeah, in the public markets, one of the great things that has changed in the last couple of years is that we finally have an active IPO market for venture-backed startups. For a long time, there was a worry in the industry about all the money piling up in the unicorns and how investors would ever see an exit from any of those companies. And that was going to be a really serious problem in VC if it didn’t get solved, if we didn’t start to have IPOs. And now that the IPO wave has arrived, a lot of the pundits are talking about we have the opposite problem, which is, I can’t believe all these IPOs are now happening. So I guess there’s always a problem one way or the other. One of the interesting things about the IPO market that I think people misunderstand is that if you google the phrase “profitless IPOs,” you’ll see dozens and dozens of articles. Everybody’s talking about, “Oh, there must be a bubble because all these companies without profits are coming public.” And I think that misunderstands the nature of what an IPO is.
Meb: Well, it shows that chart and it’s so easy to retweet, which is the percentage of companies going public that are unprofitable, it’s certainly back 2000, maybe even all-time high.
Alex: Right. But if we think about what was going public in 1999, you had the globe.com and pets.com and all of the gen one dot-coms that weren’t just unprofitable, they didn’t have viable business models.
Meb: We recently just had a guest on the podcast, you may know him, Bill Martin who runs Raging Capital Hedge Fund, who had started Raging Bull. So we were telling funny stories about he had sold his to company to CMGI and CMGI was like the poster child, late ’90s. I was a shareholder. I guarantee you I had capital loss carryforwards for a decade for that stock. Some of these names bring back a lot of not so fond memories. All right, keep going. So…
Alex: Yeah, so if you look at the globe.com or pets.com from those days, those were companies that did not have viable business models. And if you compare that to some of the profitless IPOs of today, there’s a big distinction. So on one hand, we have had for many years, this has not changed in 2018 or 2019, a lot of companies coming public that are research biotech companies that don’t have any drugs, that have gotten through phase three trials, but have drugs that are in the pipeline. And that hasn’t changed and most people, most individual investors are not buying those stocks. They’re not in indexes, people don’t have a large degree of exposure to them, and there’s not enough of them and enough market capitalization in them to make it a bubble. It’s just how we finance biotech companies, they go public after a while, usually before they have a drug on the market. So that’s that.
Then we have another class of IPOs that has not been a bubble for quite some time that I would argue is not today, which is we have a lot of private equity-backed companies, not venture-backed companies, but more old-line [SP] non-tech companies owned by the Apollos and the KKRs of the world that IPO, and many of them, IPO with significant financial leverage. They’re five or six or seven times debt to EBITDA. And they’ll have substantial EBITDA, but they won’t have net income or EPS at the time they go public because they have that leverage. The IPO itself and the cash generated from that to deleverage and then a few years of single-digit revenue growth and some operating and financial leverage associated with that will take a profit-free IPO owned by a PE firm and turn that into a solid cashflow EPS producer in just a few years. And that happens all the time. And so that’s not a sign of a bubble either.
So then the question is, are all of these venture-backed startups that are going public a sign of a bubble? And I would argue that they’re not because we need them to go public. The volume of companies like that that are going public is still not high by historical standards. It’s high by the standards of having almost no activity like that from 2013 to 2017, but it’s happening. And the companies that have gone public that have felt highly valued over the last few years have turned out to be real solid performers. Shopify and Atlassian and ServiceNow and companies like that, that felt like they were high priced a few years ago, are actually companies that have put up really, really outstanding performance in the public markets
Meb: And part of it is, you mentioned before that some of it just has to do with the SaaS business model. Meaning it’s possible that in times past, I don’t know, my mom certainly wasn’t on the internet in the ’90s and now she is buying CBD lotion or whatever she may be buying but…just kidding, mom. Mom’s our number one podcast listener. The world has changed over the last 20 years as well. Maybe talk a little bit about that, about the SaaS companies, how that might be a little bit different or not.
Alex: Software has become a totally different kind of a business model over the last 20 years. No one sells software anymore on a one-time license fee basis. It’s all sold on a subscription basis and that makes the company much more financially analyzable. It makes it much more predictable and it becomes a company that earns a different valuation multiple when that happens. And when you’re looking at a SaaS company that’s growing that incurs all of its customer acquisition costs in R&D upfront and then earns that revenue back over time, if they’re growing, they will not show gap profits, period.
And so profitability is a wrong measure there. You have to look at essentially what you might consider a growth accounting statement or a cohort retention statement. These might be the new analogues of an income statement and a balance sheet for a SaaS company. You have to look at what is their customer retention, what is the payback period on customer acquisition costs? You have to look at how well they upsell, all those kinds of things in order to have an estimate of whether it’s a good business or not. And gap accounting was not built for that.
Meb: We should have one coming down the pipe pretty quickly here soon. It’s been a lot in the news lately. There’s been a pretty wide dispersion of IPO performance this past year. There’s been some that have been flat, there’s some that have been pummeled and there’s some like Beyond Meat that have just shot to the moon. What do you think WeWork’s gonna do?
Alex: So community adjusted EBITDA is its own kind of financial metric, and I would argue WeWork is more akin to Lyft and Uber and a few other companies like that that are essentially regular companies that are trying to go in drag as tech companies. They’re not really tech companies, they’re not software companies. WeWork is basically a gigantic asset liability mismatch that is trying to call itself a tech company. And so those are the kinds of public tech companies that I would be cautious about because it’s really hard to see what a sustainable cashflow-generating model looks like for a company like that.
Meb: Do you feel there’s any disconnect or not between sorta public-private markets on valuations on some of the deals you see on any point in the sort of funding spectrum?
Alex: Really, only at the late stages where a few companies got very highly-priced by later-stage investors.
Meb: They got SoftBanked?
Alex: Yeah, who got SoftBanked, who got unicorn hunting fever. There’s news out that SoftBank may be announcing the new vision fund two sometime in the next couple of days. And it will be interesting to see how many of their LPs from fund one have re-upped. How you get any kind of returns that are materially different from what you could do in the public markets when you are investing $100 billion at a time into late-stage unicorns is a hard thing for me to understand.
Meb: Well, it’s funny because a lot of the literature shows that you can do a pretty good job of replicating the average returns of private equity or VC, which really the whole point is you don’t wanna be average there, otherwise there’s no point in doing it because you end up looking like some factor-based stock exposure. We had a great VC replication ticker that was a unicorn that we lost because I was too lazy and wasn’t paying attention. So whoever got that, kudos to you guys. But anyway, you know, it’s funny, it’s odd from someone who kind of toys around with private investing, been doing it since 2014, you read all of these amazing founders doing the coolest stuff. And every day I read these profiles and the problems they’re tackling and the success they’re having and it’s like the most optimistic industry to be a part of because these people are brilliant, the founders are, they’re hardworking.
And then on the flip side, you watch a lot of public markets news flow, and it’s like universally negative. You flip on CNBC or you flip on Twitter and everything else and I feel like all I wanna do when I consume public markets information is by puts and all I wanna do when I read about private markets and startups is invest all my money in them. So maybe that’s a good barbell, buy a bunch of puts and also invest in startups. I wanted to talk quite a bit about some sector ideas with you. I saw a great presentation that you did, but before we get to that I wanna talk about a few more sort of private investing concepts that we touched on in our first podcast. Listeners, if you didn’t hear it, go back because I think it’s really important, so important that it fundamentally can change the return stream of the asset class in very significant amount, but it’s also a topic that almost no one pays attention to or understands. I think you and I were the first ones on the podcast to go down the QSBS. You wanna give us a quick overview again for the listeners who are newer to the show?
Alex: Yeah, so QSBS stands for qualified small business stock. That is a class of companies that is defined in the Internal Revenue Code in section 1202 of the code that has some really favourable tax treatment for it. What it basically says is that if you invest in a qualifying small business that is not in an excluded industry like real estate or restaurants, oil and gas exploration, or financial or professional services, and then you hold that stock for 5 years and then you sell it to any third party, you can exclude from taxation 100% of your gains up to $10 million or 10 times your investment, whichever is greater per issuer.
Meb: Which is enormous.
Alex: Right. So if you put $50,000 into a startup, you would then have to turn that $50,000 into $10 million. What is that, 200, 400 times your money? An enormous amount of money in order to actually have to pay federal taxes. Now, if you happen to live in California like the two of us do, we still have to pay our 13% to the franchise tax board. And I don’t know what the rules are in other states. You have to ask your tax advisor about that. But you can exclude the gains from federal taxation and that’s a really big deal. Now, it’s important to note that in order to qualify, a business has to be a C-Corp, not an LLC, not any other kind of passthrough vehicle, and it has to have gross balance sheet assets of under $50 million. That’s not a valuation of $50 million, that’s total assets on the balance sheet.
Meb: Okay, so that’s interesting last part because theoretically, you could have a company valued over $50 million but just have no general assets on the balance sheet?
Alex: You could have a company that has a $200 million valuation but has no inventory, no PP&E and runs most things through the income statement and has very little on the balance sheet and would have less than $50 million of capital. Generally, when a company is raising capital, in their stock purchase agreements they will include a clause that says this company is a qualifying issuer under the QSBS rules. And if you have any doubt about whether a company is, when you’re looking at making an investment, you can just ask them like, “Can you put this in your documents if you are, in fact, qualifying?” And any attorney who routinely deals with emerging growth companies can handle something like that easily.
Meb: And so for the listeners that maybe are investing in private companies or want to or have been but not doing this, do you just select it on your tax form? Is it something you can do if you’re investing in VC firms and funds? Does it work there too? How’s it work?
Alex: Yeah, so you simply take the exclusion when you are filing your capital gains taxes. There’s a worksheet with some IRS number that I can’t recall off the top of my head that allows you to report that and exclude the taxes. And then you get that tax benefit whether you invest directly into a startup yourself or you invest into a venture capital fund that then makes the investment in the underlying startup. The one caveat is that if you’re an investor in a venture fund, you have to be an investor in that fund before it invests in a portfolio company in order to get the benefit of that portfolio company. So many venture firms are open for a year or so to take new money. So let’s say a venture firm has a first close on January 1st. And then it makes an investment on February 15th and then it has another close on April 1st. If you came in on April 1st, you would still own your pro-rata percentage of the portfolio company that was purchased by that venture firm on February 15th. But if that company then goes on to generate big gains, you will have to pay taxes on those gains if you came in after February 15th.
Meb: So does the LP in your fund elect the QSBS on his end or is it you do it? It’s probably on the LP’s end.
Alex: We basically…a venture firm will send information to the LPs about which gains are qualified and which gains are not when reporting on a K1 and they often put in supplemental instructions to CPAs for the LPs because a lot of CPAs have actually never taken advantage of this provision of the tax code before. And it does require some education from time to time. We meet CPAs and tax attorneys and folks all the time who have never encountered this part of the tax code and it really can make people’s eyes pop when you look at it.
Meb: Well, as an investor, I mean it’s like one of the biggest potential tax benefits I can even think of. And I feel like I remember seeing this, and you may or may not know, and correct me if I’m wrong too, that if the investment doesn’t go five years, you can still…if you have a gain, you can roll it forward.
Alex: That’s correct. That’s called a 1042 rollover, which is roughly equivalent to a real estate 1031 rollover. In order to do so, there are time limits and qualification limits. And so it’s something that is not super easy to take advantage of but can be done if you have enough advanced warning and are in communication with your portfolio companies about when exits are likely to happen and you have ongoing deal flow. So you have to have both sides in sync and spinning at the same rate in order to really take advantage of that.
Meb: You gotta send me your CPA later. I do all my taxes on myself and it’s an absolute mess.
Alex: I did that for the last time last year and now that I have as many LLCs and LPs involved in my taxes, this is the last year I will ever do that.
Meb: I don’t know how this still the situation, I mean our government, God bless him, but it’s so complicated. I mean you and I, you literally do this for a living, investing in finance, and it takes me like a week and I don’t even own a house. I have like the most simple investing situation on the planet and it still takes me forever. So…
Alex: Yeah, but we own businesses and so when you have all the moving pieces and entities that we do, it’s not like it’s just a single W2.
Meb: Okay. So listeners, this is a huge benefit if you do any sort of private investing. You mentioned special purpose vehicles may or may not be passthrough. I’ve heard both. I’ve heard CPAs say that it looks through if they were buying original issuance, not if they were buying stock from employees.
Alex: Yes. So whether it’s an SPV or a venture fund, the QSBS benefits only accrue when you are buying original primary shares, not secondary shares. And so the dollars that you used to purchase the shares have to show up on the balance sheet of the underlying company.
Meb: Yeah, So something like an equities in or, what’s the other one called, the secondary market share post. There’s a couple of them.
Alex: Share point, second market.
Meb: It probably wouldn’t qualify on those.
Alex: None of that does. And in fact, most of the companies that are on platforms like that are later-stage unicorns that are well beyond the $50 million balance sheet qualification stage.
Meb: We’ve had equities in folks’ on a few times and love talking about them. I’ve only done a few on there, but I think it’s an interesting kind of bridge the gap in between the early stage and pre-IPO. If you really want some, but they got a bunch on there. It’s been interesting. All right, so we’ve got a little bit of the landscape going on. We talked about, kind of, private-public situation, what’s going on with the IPO markets. You guys are finding plenty of deal flow, quality companies. How long do you have to put all this moolah to work on fund three? Does it take like a couple years?
Alex: Usually, it takes about 3 years to make new investments, and so per fund we like to have about 25 portfolio companies. You need to have enough to get the benefit of diversification and few enough that you can be active and involved in the company and be there to help the founders through all of the challenges of growth that they will encounter. And so, for us, that pace is about 7 to 10 investments per year. As we sit here in July, we have done four investments this year, so we’re right on that pace.
Meb: I feel like it’s gotta be hard to manage the spacing of that. You can’t really control the companies you meet and the timing. I feel like it’d be so challenging. If you just met like 20 in Q1 you’re like, “Oh my God, these are all amazing.” Not to get the temporal side of it, is it a challenge to manage it all?
Alex: We try not to manage it actually. We try not to let ourselves get too focused on that metric and so we’re perfectly happy to go extended periods of time between investments. Last year was a good example. We did one investment in January, one in February, and then none until the fourth week of August, and in the fourth week of August last year, we did three deals in four days.
Meb: Is it as far as over the last…when did you guys start the company?
Alex: In 2015.
Meb: 2015. So over the past four or five years, have you noticed any material difference on the competitiveness for deals? Has it been pretty stable? Has it gotten more or less competitive as trying to elbow out other VCs? I feel like you guys source a lot of years where you’re often not fighting with other VCs.
Alex: That’s usually the case. We are often getting to companies very early. They’re typically companies that have raised less than a million dollars in capital, mostly from angels or accelerators or friends and family, and where they’re looking only to raise $1 million to $3 million and we often just get to them pretty early. There are other occasions where we find a deal where we know it’s gonna be really hot and we have to move very fast. One of those deals that we did in August of 2018 was like that where it was an incredibly dynamic founder. It was a company with a product that was very charismatic. What I mean by that is that it was a physical product that was mostly software, but it had a hardware component to it and it was really easy to demo. It was really tangible and salient in a way that got people’s attention and they already had some pretty big interesting customers lined up. And so the moment we thought this one, we knew that this was going to be one of the hottest deals in L.A. that year, in 2018, and we had to move heaven and earth to be a part of it and to fight to get room on that deal and get an allocation. And luckily, we did and we’ve been very happy with that.
Meb: I’m always fascinated by, this is true with public equities too, but looking back at private deals on how…I’m sure you love all your children the same. But over the past five years, if you could have, at the time, maybe said, “Look, these are my three favourite, these are gonna be the ones,” or you like all the other ones, but maybe didn’t have the same level of confidence. At least in the short time period, has there been any translation into eventual success or do you think your initial optimism correlates to their eventual performance in ensuing years?
Alex: We have an interesting example of that. We have a company that does artificial intelligence software to help call center representatives with their conversations and to coach them live during a conversation in order to close a sale more effectively or to provide more effective customer service. And this company was founded by 3 guys who were 23 years old when they started the company, had very limited experience, and they started the company on nothing and I mean nothing. They started this on a shoestring. They got a product out on a shoestring and the first version of their product outperformed competitive products that have raised $50 million to $100 million in venture capital. And they got a handful of national customers on the basis of that. and we found the company. We had looked at a number of those competitors that had gone on to raise a lot of money and have passed on all of them.
So we had a prepared mind for this one and were able to develop a lot of conviction from meeting the founders, understanding how they had made their decisions, and then talking to their customers about why this was such a special company. So we were raring to go. We were super excited about it. And then we had to assemble a group of investors, most of whom we had never worked with before, to come in and complete the round with us. And there were a lot of doubts about the technical team of the company. There were a lot of doubts about their maturity as founders, and there were a lot of doubts about how they could have done something like they’ve done, how real could this be? It’s also a company that’s in the Midwest and they were just very far from a lot of people who are natural investors in that space. And that was a hard round to put together. That took months of effort, that took a lot of persuasion and cajoling. And from the moment the dollars went into the company last year, everything has been straight up, and I mean everything. They have hired an incredible technical team.
Meb: It would have been such a better end of the story if you’re like, “And the moment the dollars hit, they disappeared into South America, never to be seen again.”
Alex: They are signing customers faster every month. They’re cycling on their product faster every month. They’re hiring an army of young business development reps who are being trained in the most effective sales culture I’ve ever seen at any company. And that company has just completed a small internal growth round where we invited one other investor to come in alongside us and every one of the insiders put up as much money as they could. And for the one slot we had available for an outsider, we had almost nobody say no. And so we went from this being an incredibly hard to company to finance a year ago to one that everybody now wants to be in this year.
Meb: It’s so fun when you see that product market flywheel hit. I mean it just exponentially just takes off. It’s rare of course, but it’s fun when they do happen because it’s just like magic. It’s like where’s this been? And then all of a sudden, it just spreads like wildfire.
Alex: And it’s fun because some of the folks that had real doubts about that company a year ago now say, “Oh, this was totally inevitable.” And I’m like, “I had to pull you by your hair across the finish line here. It was not.”
Meb: This is probably a good segue anyway. I mean I got to see you give a good talk at…was it Casa del Mar or Shutters?
Meb: Loews. Just kidding. Neither, trick question. Just making sure you’re paying attention.
Alex: All on the same block.
Meb: Yeah, it was a great presentation, room was packed. The topic, in general, was AI, which is something a lot, in the news everywhere, I feel like there’s a lot of misunderstanding. Why don’t you just give us just kinda a little bit of an overview what’s going on in the world there, that sector, that theme? As far as with a bent towards investment implications, the robots gonna take all of our jobs, what’s going on?
Alex: Yeah, so we’re very active investors in the space of artificial intelligence and machine learning. A whole bunch of our companies use these new tools that are now available to solve problems that had never been solved in software before or to automate processes that had never been automated before. And we’re extremely bullish on that sector. We think that we’re in the very early innings of a deployment phase that is gonna take decades, probably the rest of our professional careers to really play through and it’s gonna create a tremendous amount of value. But I think people have seen too many Hollywood movies about terminators and matrices and the like that they’ve gotten really worried about AI taking our jobs, and we actually have the opposite view. We’re massively bullish on AI from an investment perspective, but simultaneously, we think that it is silly and premature to worry about the effect of AI on the job market, and we have that view for a few reasons. Number one, it feels funny that people are worrying about job loss when we have the lowest structural unemployment in 50 years
Meb: And is knocking on ever, it’s getting darn close.
Alex: Yeah, and if you look through the headlines of the core unemployment rate and into some of its components, it’s even better than it looks in a lot of ways. Labor force participation is about as high as it can get adjusted for the age of the population. There are basically no workers in the workforce left that can be absorbed into the workforce right now. We’re getting maximum penetration of almost every demographic and it doesn’t seem likely to change. Obviously, we will have economic cycles in this country and unemployment will go up when that happens.
Meb: May never happen again. Trump may be here for life. I don’t know, Rubalcava, we’re gonna have to watch the next election at a different bar this year, or next year, whenever it was.
Alex: Oh man. November of 2016 was quite a night, wasn’t it?
Meb: Where did we watch that? It wasn’t Bigfoot. What was the name of the…?
Alex: It was somewhere in Culver City.
Meb: Okay, we’ve got to pick a different location.
Alex: And I remember when we saw the Florida numbers come in and you and I both whipped out our phones and started doing the math on that and kind of looked at each other silently and said…
Meb: No, no, no, no, that’s not how it went down. You did the math. I was just blissfully just watching TV and having a beer. And you said…your face was drained of color. You said, “This is it. It’s over.” Everyone was cheering. There was like confetti going on in the room. And then you said, “No, this is it.” You should have been online on the betting markets, trading the futures at that point.
Alex: I guess I should have. Yeah.
Meb: All right. So the business cycle you think isn’t just totally caput, keep going.
Alex: Right. So one of the reasons that we’re very skeptical of this idea that the robots are gonna take all of our jobs is because we think that there are gonna be more job openings than we can handle and that the robots are not gonna be coming fast enough. And one of the reasons we think that is that there has been a real shift in the demographics of this country over the last 10 years that I don’t think a lot of people are paying attention to. What I mean by that is that in the 40 years before 2010 or so, our country was dealing with the absorption of 5 simultaneous supply shocks to the labor market that all conspired to make low-skilled, low-wage labor, abundant, fungible and cheap. And those supply shocks were the fact that we had manufacturing go from about 25%-ish of jobs down to 7% or 8%.
We had, especially in the early period in the ’50s, ’60s and ’70s, women entering the workforce for the first time and the discrimination that was present against women that is still present has held down wages in the industries that they have tended to go into. We have had weak and underperforming public schools that did not help equip kids with the skills that were necessary. We had immigration to this country that was tilted towards low-skill immigration and we had a wave of mass incarceration in the country that left a lot of people, once they came out of incarceration, with very limited job prospects and a lot of hostility to them from employers. And what’s interesting is that every one of those supply shocks is over. Every single one is over. Some of them are easy. There’s no third gender to absorb into the workforce. That process is over.
You can’t lose 25% of manufacturing jobs again because we only have 7% of the total labour force that could even be lost, and I would argue we’re probably pretty close to a floor there. Low-skilled immigration in this country has basically been over for the last 15 years. The modal person coming to America today is a Southeast Asian with a master’s degree, not someone from Latin America with an eighth-grade education who is entering illegally, which is what it was in the past and it is no longer that. That’s partially because demographics in Latin America are so different. The fertility rate is so different there. The educational achievement is so much higher than it used to be that the incentive to migrate is different from what it was. I’m speaking broadly. There are certainly places in Central America where that’s not true today.
And then mass incarceration is something that I don’t think a lot of people are paying attention to, but the incarceration rate, the prison population, both of those numbers peaked eight or nine years ago and have been coming down at mid-single-digit rates. And it’s only gonna get faster because if you look at the demographics of who’s incarcerated, it’s basically people our age and older, people in their 40s, 50s and 60s. If you look at 18 to 21-year-olds, their incarceration rate and their rate of committing crimes relative to even just 20 years ago is down by like 70% or 80%. So the prisons are all gonna be empty in a few years and we’ll have an entire new generation that will be graduating from college that will never have been in prison, that will be working in good jobs.
And none of that generation, none of the people that that describes are ever gonna wanna pick lettuce. None of them are ever to wanna flip burgers. None of them are ever gonna wanna be truck drivers. They’re not gonna wanna be security guards. And so all of these kinds of jobs, all of these kinds of businesses that were built on the assumption, and it was always an implicit assumption, nobody ever really thought of it this way, that this kind of labour was always gonna be there, that it was gonna be interchangeable and that they would never have bargaining power. That’s over.
And one of my favourite places where you can see that where any of your readers can go and just look at the data themselves is look at publicly-traded restaurant operators. Look at the Chipotles of the world or the company that owns all the Burger Kings, Carol’s Restaurant Group. Look at any of these companies and look at what labour as a percentage of revenue was 8, 10, 12 years ago. You can exclude like 2009 because 2009 was a tough year. But look at those financials in EDGAR and what you’ll see is that labour was 22%, 23%, 24% of top-line revenue then. And for most of these companies, labour’s now 30%, 31%, in some cases 32% or 33%, and these are businesses that have like 7% or 8% EBITDA margins. If they’ve been able to maintain those EBITDA margins, which not all of them have, they have taken out massive amounts of costs elsewhere in their business. They don’t have that kind of cost-cutting left available to them. If we have another 700 or 800 basis points of inflation in low-skilled labour, those businesses break. I believe that large amounts of businesses that are built on low-skilled labour in America are in the process of breaking and we don’t realize it yet.
Meb: So short all the low-skilled labour, go long the AI, or I guess it’d be a barbell, you go long both because it would benefit them if they started to get some development.
Alex: You short the employers that are unable to respond quickly enough.
Meb: Right. All right, so talk to me a little bit about some investment implications. What are you seeing is in the AI space or you can talk about a little more of the science if you want, what’s going on, any developments, blank slate?
Alex: So at a high level, any kind of AI that is being deployed today commercially is doing one of four things. It is doing segmentation, optimization, anomaly detection, and recognizing objects that we use the pneumonic SOAR, S-O-A-R, to describe those four things. And in general, commercial AI systems are being built out of those blocks in order to do one of two things. They are automating a process that used to be done by a human or they are making a prediction about the future that used to be done by a human. That’s basically it. Like that’s what’s being deployed commercially today. There will be more building blocks that are coming out of academia today that will be part of the commercial toolkit of AI in 5 or 8 or 10 years. But that’s what’s commercially available.
And so one of the things that it’s doing is that AI is tending to make things that used to be expensive cheap. And when you take something that used to be scarce and expensive and you make it cheap and abundant, you end up consuming a lot more of a particular resource. One of our favourite examples of that is banking. When ATMs came out, people thought that there would never be bank tellers anymore. And there are more bank tellers today than there were in 1982 or ’83 when ATMs first started coming out. What has happened is that we as consumers use a lot more banking services today than we did when ATMs first came out.
So today, one of the first applications where the core building blocks of AI are immediately applicable is analyzing radiological scans, basically doing what a radiologist does, looking at film. That kind of computer vision application has been well demonstrated. And so you get a lot of people saying, “Oh, you know, all the radiologists are gonna be out of jobs.” That’s not what’s gonna happen. What’s gonna happen is the world is going to consume much more radiological services in the future than it does today. We’re probably gonna have the same number of radiologists doing 10 times the amount of work that they’ve ever done before and serving 10 times as many people and creating good outcomes as a result of that. And I think that’s a better way of thinking about what the market is gonna do when there’s a new technology. We should be thinking about how can we waste this technology? How can we use it in ways that would feel frivolous or profligate to us today because there’s no marginal cost associated with it now? And you’re gonna see that across all sorts of applications, but it’s also gonna take time.
Meb: So, and you can take this any way you want, are there any sort of case studies, examples, portfolio companies, anything that you think is a good example of what’s going on in that world or opportunities that you would like to see someone tackle that hasn’t been? What’s kind of the lay of the land as far as maybe some real-world examples of what’s happening?
Alex: So we have a company called VeriSIM Life. VeriSIM Life uses artificial intelligence to build biosimulation models that mimic the way that many species of animals absorb drugs into their system. The way they metabolize, absorb and react to drugs. The application here is that every drug that gets through FDA testing and becomes a drug that we can all take has gone through animal testing before it went through phase one, two, and three human testing. That animal testing is not super accurate. It is expensive and most importantly, it’s really slow. It’s really time-consuming and there is nothing more valuable to a pharmaceutical or a biotech company than time. From the moment that they file their patent application to the moment they get a drug on the market, that can be 10 or 11 years. That could be a billion or $2 billion of R&D, but if that drug can generate $2 billion or $3 billion or $4 billion a year in sales, you can get that drug to market 6 months earlier, that’s $1 billion.
And so if you can take animal testing and instead of having to test a drug in 40 rats or in 10 monkeys and deal with the amount of time that’s associated with that and just figure the right drugs to test and the right animals to test them in at first and then one day skip that process, you could create an enormous amount of value. And you’ll end up opening up what animal testing used to do and the ability to get drugs to market to a much greater number of biotech and pharmaceutical companies at much lower cost and to many more academic labs and universities than has been the case before.
Meb: And where do they kind of stand in the process? Are they pre-product, they started to build it, they built it?
Alex: We invested in the company when they had been incorporated for 45 days and they were a 2-person team without a line of code written and a single customer. They are now about a dozen employees. They are working with the bluest of blue-chip pharmaceutical companies, the bluest of blue-chip research hospitals and academic labs in the country. What I love about the founder of this company is that she didn’t waste time with the B and C players in the market. She went straight to the top and has built just the most incredible customer base you could ever want. And that really gets the industry’s attention when you’ve got this kind of a customer base.
Meb: What’s the ideal sort of structure of that company? Is that that customers are all the pharmaceutical companies and research institutions? Is it something that they would rather be an arm of one eventually get acquired? Like what is the eventual evolution of that?
Alex: That company will not be able to achieve its mission if it gets acquired by one of its customers. And the reason for that is that one of the things that makes AI valuable is large amounts of proprietary data that other people don’t have. If you don’t have proprietary data, if you go out and you say, “Oh, we have better algorithms than everybody else,” then you might have a competitive advantage that will last for 90 to 180 days. The algorithms are consistently being improved, the cutting-edge work is always being published in academic papers and being released in an open source way, and it is an unsustainable way to build a company. But if you have data that nobody else has, that’s sustainable. So in the case of a company like VeriSIM, they have convinced their customers to share the results of the animal testing that they have done historically and contribute that data into VeriSIM’s data co-op. And you can imagine what a conversation like that must sound like to a general counsel of a pharmaceutical company. “You want me to do what?”
But good AI companies can convince their customers that the value that they will receive from contributing their data to the data co-op will vastly exceed what could potentially and rarely actually happens if that data was ever lost. And as a result, every customer that a company like VeriSIM signs up, the more powerful their product becomes. And what we like about this company, in addition to all the things we’ve already discussed, is that no one was really trying to do this before VeriSIM. There are a few companies that have built biosimulation software on technology stacks that are 20 years old, but no one taking a modern machine learning approach to it.
When we talked to the customers when we were doing our due diligence on the company, they said, “Yeah, there’s not really a lot of people in the world who know software and machine learning really well and who know animal testing really well. But Jo Varshney is a doctor of veterinary medicine and a PhD in comparative oncology and computer science and she’s worked in all these blue-chip companies in the industry.” And they basically told us, “We would laugh anyone else out of the room if they tried to do this. But with Jo, we have to take her seriously,” and that’s the kind of thing that gets me to whip out my chequebook.
Meb: So propriety dataset, seems like that is…having access or generating them is a huge competitive advantage.
Alex: That’s correct. And it’s a real challenge in terms of creativity for founders to figure out where to get them from.
Meb: Is it a use case where the companies or others that have the datasets try to extract either a monetary economic toll for that often or is it more of just a horse trade? Like the pharmaceutical companies, they know that it benefits them, like what’s the…little bit of both?
Alex: The best case is when it can be transacted in a way that’s mutually beneficial and that doesn’t require a cash payment. Often, the companies that possess the data that is valuable for a machine learning startup are not capable of exploiting that data themselves. They don’t have the people, they also may not have a critical mass of the data. You might need 10 customers’ datasets in order to build the minimal version of a working product. And obviously, those 10 customers who are all likely to be competitive with one another are never going to come together to do this of their own accord. If they were to do so, that would be a real interesting invitation to antitrust regulators.
Meb: All right. That’s a pretty cool company. You got any more that you’re particularly enthused or you think are fun ideas?
Alex: Yeah, we have a company called Placer.ai.
Meb: I feel like I’ve heard of this one. Have I heard of this one?
Alex: Probably seen me tweet about it. And so Placer develops software to provide location intelligence and foot traffic analysis to owners of shopping centres and commercial real estate. The way they do that is that they have a location data SDK, a software development kit, that collects data from a lot of cell phone apps. What it does is it then anonymizes it and aggregates it in a way that produces a map-based interface showing where people are coming and going just on a dot basis to real estate properties. And you can use it to do all sorts of really interesting things. If you have a multi-chain restaurant, you can use it to inform the decisions you’re making about where to put a new location so you don’t cannibalize your existing locations. If you are a landlord and you’re in tenant negotiations with a supermarket or with any other retailer that’s talking to you, you can see the kind of traffic that they’re getting and how it compares to other units in the chain. If you are a tenant and you’re thinking about where I want to locate, you can locate next to complementary stores and in centres and malls where you don’t have access before and where the demographics would be really similar. That company is growing tremendously fast. It’s a really, really exciting company and…
Meb: I feel like that’s the plot of the Batman and Joker movie. Doesn’t Batman have that ability where he takes over all the cell phones and geolocates and that’s where Alfred’s like, “I’m done. I’m not helping anymore because…” Or not Alfred, Morgan Freeman says that where he’s just like, “I’m done. This is too Big Brother of you to…” Batman was using it to…I don’t even remember at this point, but…
Alex: So that’s one of the things that people often think about is that it feels somewhat like people are tracking them individually. And what’s funny about that is that nobody is valuable enough that tracking them individually has any commercial value. You and I do not shop enough that knowing right where we are is going to move the needle as to where a supermarket wants to locate their next store. But in aggregate, data about all of us is really valuable. And so that’s what’s cool about Placer is that Placer is never going to report to anybody. In fact, it’s not even possible on their tech where Meb or where Alex is right now or where they have gone, that’s not commercially valuable and that’s not even a part of the product. But where large masses of people go, how frequently they go, how long they’re staying, in aggregate, in dwell time, that stuff has really profound commercial value and it’s no different than the way that websites collect that data with cookies. It’s exactly the same. We’re just equipping offline businesses with the same kind of tools that online businesses have had from the start.
Meb: That’s a fun one. Most of these located in Cali or you said you had one in the Midwest, is it kinda all over?
Alex: Placer has their headquarters in Santa Cruz, but they also have a very large team in Tel-Aviv. VeriSIM, the company I mentioned to you earlier, they’re based in San Francisco. We have a company in St. Louis called Balto Software. They’re the ones who do the call center software. And so we have companies everywhere. We have a company in San Luis Obispo, which is not necessarily a town that…
Meb: Famous for their barbecue.
Alex: Exactly. And so we have a company in San Luis Obispo that does drone detection and mitigation, so they can protect critical facilities like nuclear power plants or military bases from people flying commercial drones over that restricted airspace. We can detect them and we can mitigate the threat, which is to say that we can essentially issue new commands to that drone.
Meb: Okay. Hold on. Stop and say that again. So the way you’re taking down the drone is, it’s not some land-air missile. It’s not another drone. It’s somehow…
Alex: No, it’s all software. It’s all RF communication. No physical interdiction.
Meb: No kidding. And what does the drone just do, just goes home?
Alex: Yeah. You send it back.
Meb: And that works?
Meb: I saw a great YouTube video the other day that was around 4th of July that someone, a neighbour had equipped their drone with a Roman candle who was tired of their neighbour being too noisy, so the drone is going over shooting Roman candle fireworks at everyone. We’re not too far away from a drone situation, I feel like, getting a little real and pretty scary at some point.
Alex: Well, it’s a pretty interesting thing because it used to be sufficient to protect a property, to build a fence and to put up some cameras because you did not need to protect the vertical air column above your property. You just had to prevent somebody from jumping 20 feet or putting a ladder up and coming over to your property. Now that anybody can buy a drone for 800 bucks and fly over any fence in the world and deliver a payload or conduct surveillance, security means something very different from what it used to be.
Meb: It’s surprising you haven’t seen more, I mean, knock on wood, more violence or terrorism or nefarious things going on with that already.
Alex: You wanna know what the biggest nefarious use of drones is in the world today?
Alex: Getting contraband into prisons.
Meb: Oh no way. They just do like a drop. Does it have to be high enough that no one can see it or does it actually they just go by at night or what’s the…?
Alex: At night a prison is so large that it’s essentially impossible to see a drone, especially if you just put a little bit of black tape over the lights on the drone.
Meb: Do you own a drone? I need to get a drone.
Alex: My partner, Rob, has a drone and he is a very avid drone photographer and we use all of his photography in our quarterly reports.
Meb: Like the only reason I can think of to possibly get one is either to just like record almost like sports bloopers, like our friends playing volleyball or surfing or something. Just totally nonsensical. I really have no use case for one, but I just feel like I should buy one at some point.
Alex: They’re fun. They’re a fun product. They can do really interesting things. There are lots of commercial applications for inspection, for analysis, things like that.
Meb: Listeners, Alex is my go-to human version of Wirecutter. I had pestered him about when I was trying to get educated on VR and I don’t even remember the system I bought, PlayStation maybe. And I don’t particularly have a addictive personality, but I had bought the VR system and remember I was like, “I’ll try it out.” And, “My God, this is kind of amazing.” The problem with VR when I was using it was that it’s very much a solo endeavor at that point. And back to the days of playing NBA Jams and video games, Tecmo Bowl with your friends. When we were growing, it was a very social but it felt very antisocial. But it was almost like watching an immersive movie.
But I remember I was like, “I’m gonna try this,” one night and my wife was like, “Okay, whatever, I’m going to bed.” And then just heard this like, “Meb, Meb?” And I like lift up the hood and Jackie, who, you know, is like, “What are you doing?” I’m just like sweating with like cramps in my leg and I’m like, “Just playing aliens shoot ’em up.” She’s like, “Do you know what time it is?” “I was like, “No, why?” She’s like, “It’s 4:00 in the morning. You’ve been doing this for like six hours nonstop.” And I’m like, “Okay, well, I just gotta defeat this mothership real quick and I’ll be down.” But anyway, it was amazing to see the possibility of it. So you’re my go-to for tech ideas, so you’ll have to send me the correct drone to buy and any new fun ideas.
Alex: Will do. And VR has been an interesting market. We looked at hundreds of VR companies a few years ago and that’s been a really challenging sector. We actually have not invested in any VR companies, but it’s an industry where they’ve been waiting and waiting and waiting for a real killer app and it hasn’t arrived yet and it’s not clear whether that will arrive a year from now or 5 years from now or 10 years from now.
Meb: And you can see the flashes of potential like the Pokemon game where it took the world by storm for a little while. When you experience the VR, you’re like, wow, I can see how this has potential, but it’s clearly not whatever the…going back to the magical product market fit, it’s not there yet.
Alex: No it isn’t. And even in AR, like in augmented reality like Pokemon Go. Pokemon Go was a big sensation. It is still having significant activity today, but there have not been large and ongoing subsequent titles or applications like that. An AR is doing 10 times better than VR. VR is really struggling and, in particular, because it is such an alone type of experience, it doesn’t lend itself to a lot of the things that people wanna do. The smartest thing anybody ever told me about VR is that VR is the most effective form of contraception ever invented.
Meb: That used to be video games of any type. Well, but that’s probably the eventual product market fit, of course, porn is like always the first way to monetize any of this stuff.
Alex: I meant in terms of how isolating it was.
Meb: I know, I know, but I’m saying that was video games in general, but now that e-gaming is such like a big thing, who knows? I don’t know. We gotta start winding down, sadly. You gotta go find some new companies to get to this afternoon to chat with. I think we should just do this quarterly from now on, just have you in because I’ve got about another two hours of questions. As you start to…we don’t do the normal questions because you’ve answered them before. But because you look onto the horizon, what’s the pathway, runway for you guys? Is it just to kind of every three years keep launching these bigger funds? Do you foresee expanding in any other areas, geographies, public companies? What’s the future look like?
Alex: We just wanna keep backing great startups and to keep meeting great founders. And we’re very lucky that we get to do that and we get to do that at extremely high volume and with the companies that we do eventually invest in with a lot of intensity and heart and energy. And we wanna help build companies that are solving hard problems that matter. We really like taking that kind of technological risk. We really like being at the real cutting edge and a lot of the people that we back are doing stuff like that.
Meb: So if there are some of those listening, I’m sure there’s lots, how do they get in touch with you?
Alex: You can find me on Twitter, @alexrubalcava. Our corporate Twitter account for the fund is @stagevp. And if you go to stagevp.com, there is a contact us form and we’d be happy to learn about what you’re doing.
Meb: Are you a DMs open guy?
Alex: I am a DMs open guy and we’ll see if I regret saying that.
Meb: Well, I just recently…I shouldn’t admit this now, I just recently, quietly, without telling anyone, went DMs open and 8 out of 10 are incredibly thoughtful and respectful and decent, 2 are not. But it’s been pretty great, actually. So I’m surprised. I was like, “I’m gonna do this for two days and immediately regret it,” because it’s kind of the opposite of comment sections for some reason because I guess it’s personal messages. I don’t know. But I’ve had a good experience so far.
Alex: I promise I won’t tell anyone your secret. Don’t DM Meb.
Meb: What do you got planned for the rest of the summer besides work? You doing anything fun?
Alex: Going up to the Canadian Rockies to Banff and Jasper.
Meb: Oh, you know, I’ve never been. I’m actually…I may be there in November just hiking around, the film festival. What are you doing?
Alex: Hiking around, whitewater rafting.
Meb: Supposed to be gorgeous.
Alex: Checking in…
Meb: Been before?
Alex: Never been to that part of Canada.
Meb: When are you going?
Alex: A few weeks.
Meb: Oh awesome. I’m gonna be up in Vancouver area, but later in August, so…
Alex: Sounds good.
Meb: I’ll miss you by a few. Alex, thanks for joining us today.
Alex: Thanks, Meb.
Meb: Podcast listeners, we’ll post show note links to all that we talked about today. Companies, websites, Alex’s Twitter handle, all that good stuff, links to Stage. And you can find show notes, everything else, mebfaber.com/podcast. Shoot us any feedback, questions, comments, email@example.com please leave us a review. We love reading them. Thanks for listening, friends, and good investing.