Democratizing Access to Late-Stage Venture-Backed Companies with Christian Munafo

This is your host, Doug Heikkinen. And today, we're welcome. We welcome Christian munafo, who's the chief investment officer at Liberty street advisors. We have a super topic today, late stage capital investing a specialty of liberty Street. Welcome, Christian.

Christian Munafo  00:38

Doug, it's great to be with you this morning. Thanks for having me on.

Douglas Heikkinen  00:41

For those that may not be familiar, can you explain what late stage venture capital investing is, and what a secondary strategy entails?

Christian Munafo  00:52

Sure be happy to. So let's start with the proverbial two guys or gals in a garage in Silicon Valley, trying to engineer a new software application, or perhaps a technology that's a bit further along at the beta testing phase before executing on an actual go to market strategy. That's not what we do. There's nothing wrong with a strategy like that. But the earlier stage nature of those companies comes with a different risk profile. So instead, we focus on what is called later stage venture capital and growth oriented investing, which basically involves looking to build access to companies that have moved well beyond their startup phase of development and the associated technology risk. They've often validated the value proposition for their product or service, they have an established market presence. They've already built out a management team and employee base, they've started generating significant revenue traction, often across a broad customer base, while demonstrating attractive growth metrics and are on a likely path for an exit event, whether that accident then be a merger acquisition or a public oriented offering within the next few years. So that's kind of a very high level description of what late stage. venture capital and growth investing involves, in terms of secondaries investing. So secondaries, I'll just touch this at a high level, it's essentially a way to provide existing investors and shareholders in the private markets, which includes venture capital and growth, to receive liquidity for what are illiquid investments. And that could range from someone owning an interest in let's say, a venture capital fund, to working with managers of venture capital funds to solve potential liquidity challenges they're facing, and then all the way down to working directly with investors and employees, of companies. And so it's really trying to provide liquidity in an illiquid market. And you know, just for some perspective, and perhaps we'll touch on this more as we go through the podcast. You know, when I got involved in secondaries back in 2005, there was roughly 6 billion of annual reported transaction volume involving secondaries transactions, whereas now today, we're on likely $100 billion run rate. So it's been a very high growth market. So that's a very high level description. But we can dive in deeper as we progress. Yeah.

Douglas Heikkinen  03:49

This isn't something we hear very much about in our industry. You mentioned you've been doing it for a while. So how did you get involved in it? And why did you pick this?

Christian Munafo  04:00

Yeah, it's one of those things where it just kind of crossed my path, I guess you could say, I started my career as an investment banker, over 20 years ago, spending most of my time in the tech TNT, if you will, space. I later went on to work closely with venture backed companies, helping them to optimize their business and operating models, as well as helping them raise capital. And it didn't take very long, Doug for me to get hooked on all of the private innovation that I was seeing in this venture capital ecosystem. And so I was contacted along the way, by a firm that was looking for someone to help build out their secondaries practice. And as I started learning more about what this market involved, as well as the trends I was seeing, with more and more capital flowing into the private market. It became clear to me at the time this was an asset class that was poised for significant growth, as there was likely Going to be an increased need for liquidity solutions, as more and more capital came in, for an asset class that structurally illiquid. And so the more time I spent with venture capitalists and growth investors and the management teams of the underlying technology and innovation oriented companies I was looking at, while understanding the challenges they were they were facing, you know, I was one of the early secondary investors that really began to develop more complex liquidity solutions, that I've only recently become more mainstream. And I guess you can say is what compound in my interest even further, was the level of inefficiency compared to public market investing, which often allowed me to enter into companies and funds in this area, at what were attractive discounts to their fair market value, or their intrinsic value, which really set things up nicely, to generate attractive risk adjusted returns for my investors.

Douglas Heikkinen  06:13

We all understand IPOs. We know, Airbnb coin base, tell us more about why this opportunity is so interesting.

Christian Munafo  06:22

Sure, so the the most important point to understand is, and I've probably said this two or three times already, you know, this is a structurally illiquid asset class. And because of that, there's arguably greater inefficiencies and dislocations than we might see in the public markets, because there's no, you know, ubiquitous private market exchange, where you can buy and sell securities in these, you know, interesting high growth, innovation oriented companies at the click of a button on your favorite brokerage platform, with price optimization and all the other great benefits we have with public market investing. And this is quite important. Because what it does is it allows sophisticated investors to essentially take advantage of these inherent inefficiencies on behalf of our investors, so that that's one of the reasons. Another reason is, you know, if we look at the last decade alone, there's been about $6 trillion committed to the overall private market, of which roughly, you know, call it one to one and a half trillion has been allocated to venture stage opportunities. So it's a very large market that we're looking at. Also, in, you know, perhaps we'll touch on this later as well. We've seen very clear trends over the past couple decades, where the number of publicly traded companies has essentially been cut in half, while the number of private companies continues to search, and they're also staying private for longer and growing into much larger, more valuable businesses. So your your average investor, your average public market investor, arguably has less opportunities for alpha generation in the public markets, while there's significant asset growth and capital appreciation happening in the private markets. And then I would just say Finally, advances in technology and innovation, that are typically developed and financed by venture capital investors. And similar players in the ecosystem just continues driving significant change across practically all industries, which we were just reminded of over the past year with COVID. So you know, this asset class in particular, within the private markets, in our opinion, is an extremely exciting place to be. So I guess to summarize, you have a very large, inefficient market that allows for attractive risk adjusted returns for opportunities and very exciting technology and innovation oriented companies, which can compliment an investor's public market exposure. And due to the way these private markets operate, most private market strategies tend to be non correlated, the public markets and exchanges, which is which is even another important point for portfolio construction to consider

Douglas Heikkinen  09:31

As the market opportunity and this type of investment strategy, been around for a while, or are companies getting smarter in your opinion? So it's a kind of a newer thing that you're paying attention to closer?

Christian Munafo  09:44

Yes, it's I mean, if I compare the current market education, versus you know, 15 plus years ago, when I got involved in secondaries, we've come a very long way. You know, the most significant trend we've seen As I noted, you know, a couple moments ago over the past couple decades, is that private assets are staying private for longer. And what we're seeing as a result of that is, you know, this protracted lifecycle of these companies allows for them to grow into much larger businesses, and much higher valuations by the time they go public, or in many cases, get get acquired. And so and so that's a very important trend to understand. And, you know, we need to understand that not all shareholders, whether they're employees or investors of a private company, have the same liquidity horizon. Right, if we look back to the 90s, venture backed companies were typically going public and roughly four years from inception, whereas now it's taking on average more like 12 to 15 years, and in some cases even more. And, look, while there may very well be good reasons for them to stay private for longer, the protracted lifecycle often creates friction within the ownership structure of venture and growth funds, and the underlying companies themselves. And this is primarily what we try to sell for, by providing liquidity options for structurally illiquid securities, while of course, building diversified access to our clients, you know, so that's, that's something that has definitely become more prominent, and I think, widely accepted in recent years. And, you know, if we look at the average market caps, also, of venture backed companies over that same time period, the average market caps of companies that are going public now, are close to 800%, higher than what we saw back in the 90s 800%. So again, there's massive capital appreciation happening in the private market. And so Doug, when we think about companies that, you know, many of us know, like Microsoft, and Apple, Oracle, and Amazon, most of the value creation in these companies has occurred publicly, which, which, because they went public earlier in their development, which has allowed the vast majority of investors to be able to access that growth. But because a significant amount of this value of accretion is happening, before many of these companies go public, it's that much more important to be able to access these companies. And that's also why you tend not to see such a significant run up in value, once they once they go public. And then I would just say, you know, as well, you know, the private market investors that typically, you know, invest in the last round of financing, you know, are often doing so because they think there's going to be some type of a pop before they answer the public markets. And so we're seeing more and more companies trying to establish a foothold before they go public. But for all these reasons, and given all the money that's come into this market, there's just a really large pent up supply of these late stage companies. That's not to imply that they're all going to succeed. Because they're not all going to be success stories. But overall, we continue to think for the reasons I just talked through that the markets come a long way and understanding the value proposition.

Douglas Heikkinen  13:47

How broad is the universe of these companies? And where does Liberty Street focus?

Christian Munafo  13:54

Sure, yeah. So the the opportunity set is is quite significant, you know, so so within Liberty Street and within the fund that we manage that focuses on this, which is called the private shares fund, we're focusing on usually companies that are generating at least $50 million in revenue. Sometimes we'll go a little bit earlier if we have reason to do so. But the reality is most of the companies we're investing into are often doing hundreds of millions, if not billions in revenue. They're companies that we think have strong differentiated and sustainable operating models going after large addressable markets, of equal importance. They have experienced operators across the management team, well heeled investors sitting on the board that are that are well aligned. And based on the diligence that we do, there's there's likely to be an exit within call it two to four years at a value that we think is well above our entry point. We look, we look around the globe. So we're not just investing in US companies. But that is the majority of what we do. And we're not just investing through secondaries, as I was describing, we can also invest in what are called primary investments, which means you're just investing in a new round of financing. And when you look at our portfolio, what you'll see is a significant amount of technology and innovation, but across a broad variety of underlying industries.

Douglas Heikkinen  15:33

When we were chatting earlier, you mentioned that Liberty Street is democratizing access to these type investments. How are you doing that?

Christian Munafo  15:42

Yeah, great question. So if you're an institutional investor, or a high net worth individual, with the proper accreditation requirements, and the ability to make large investments, you may already have opportunities to invest in private markets, through, you know, your typical, you know, 10 year life fund with, you know, multiple extensions. But that, but even if you have access through your accreditation and investment size, the venture capital market in particular is an asset class that's fairly closed, we're not even, you know, well, for accreditation can guarantee you access to very closed circle. And, and that's where, you know, myself and my colleagues have spent most of our careers. And so we have very deep relationships into this into this ecosystem. But what we just talked about, that leaves out a very large demographic of investors who don't have the proper accreditation requirements, or may not be able to make large investments. And that's exactly what we had in mind when we created this fund. So well, we have dug, we have a registered fund, under the 1940 Act that has been structured as what is called an interval fund. And with this structure, we are able to essentially democratize access to this strategy to all investors. So Main Street can be investing in late stage venture backed companies. And unlike the typical private funds that come with burdensome subscription documents, you know, k one tax reporting, perhaps in frequent valuation reporting, multiple layers of economics, we essentially enable advisors and investors to invest in our fund, simply using a ticker, kind of like how they may purchase a mutual fund on their favorite exchange, and we have 1099 reporting. So it's easy tax reporting, we value our funds daily, we often offer structured quarterly redemptions, up to 5% of the the net assets of the fund. So what we've essentially done is allowed for all investors to be able to access this private technology and innovation through a very seamless fund structure.

Douglas Heikkinen  18:11

What advice do you have for advisors who might be considering this type of investment

Christian Munafo  18:15

for their clients? Yeah, the most important advice I would say is that while we've made, we believe we made the fund easy to invest in, and provided for quarterly redemptions to truly benefit from a strategy like this, you need a multi year investment horizon. So when I was, you know, talking earlier, through, you know, the types of things we invest in, you know, what I said is, we're typically looking for investments that we think have the ability to harvest within two to four years, from our investment date at a value that's substantially higher than when we got in. But in order to benefit as an investor in our fund from that, you need to have a multi year horizon. So you know, investors or advisors that may try to come in and out. One are not going to do us any favors, because it can create some challenges for us from from a fund liquidity standpoint, but it's just not going to provide the return profile and benefits that it's designed to offer. And so you know, I guess what I'm saying is Doug, one of the most important things we tell advisors is that we're looking for, for patient longer term capital. We also tell advisors that even if they have clients who are fully accredited, with an ability to make large investments in the hundreds and 1000s of companies that are available, they still may prefer using a fund like ours, given the administrative ease. So we also tell them, Look, even if you have clients that are large and accredited, this may also be a solution for you. And I would just say Lastly, and I pointed this out earlier, we often find Doug that advisors like the fact That our fund is non correlated to the public markets, which on its own, can be a prudent diversifier within their client's portfolio construction. So hopefully that those are those are good. Good points of advice.

Douglas Heikkinen  20:16

Great points, and it's a fascinating opportunity. Christian, we really appreciate you joining us today. Thank you so much for your time.

Christian Munafo  20:25

It was a pleasure. Thanks for having us on.

Douglas Heikkinen  20:26

You can learn more about Liberty street advisors by visiting Liberty street funds.com. Please follow us for all the latest updates on Twitter, LinkedIn, and Facebook all add advisorpedia. For everybody at advisorpedia our producer Jakie beard and the power your advice podcast team. This is Doug Heikkinen

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