Intro

Patrick: [00:01:20] I have a special request this week, which is to share this episode with every curious person in your life. The conversation with the 26-year-old investor named Ali Hamed serves as an example of what's possible when you think creatively. Ali views the world with a fresh set of eyes and has already become an expert at identifying new investment opportunities where others have not. As the second prodigy, 26-year-old in his many weeks on the podcast, these young guns are making me feel like an ancient 32-year-old. We talk about alpha in our world, earning returns better than the market. But the keyword in that last sentence isn't alpha, it's earning. Hopefully you, like me, will use this conversation as a reminder of what it takes to earn differentiated returns. It's not just the hard work, but also the mindset. We explore many examples of how to create new investment opportunities, from rolling out the Instagram accounts, to financing perishable fruit like watermelons, to heavy machinery software. Please enjoy this special conversation with Ali Hamed. Follow him and his partners and then go figure out how to earn success yourself in whatever it is you do by helping others solve problems with empathy.

Ali's Investment Philosophy

So, Ali, I'm going to start with a question that, as I'm thinking about it, I don't think I've ever actually asked anyone on this podcast, which is for you to describe your investment philosophy overall.

Ali: [00:02:34] I think that our investment philosophy has been, we go into every single investment saying, is this a trade or is it business? And if we think it's going to be a one-off trade we probably won't do it. We look at every new investment opportunity, whether it's something within a current fund or a new potential fund, as can we get an unfair advantage? Can we build a sustainable advantage, where we understand why our team is uniquely positioned to get an outsized return? Do we think that we could do this a bunch of times over and over again? And do we think that the more times we do it, the greater advantage we'll have over other competitors? An example of something we wouldn't want to do is say, "Hey, we've discovered this thing and now that we're doing this thing everyone else is going to realize it's also a good idea." And I would be nervous to get on this podcast and talk about it. The minute I'm nervous to get on this podcast and talk about one of our investments, it means it's not defensible enough. I never want to be the guy who's winning because I have a secret and god forbid anyone else finds out about the secret. So I guess that would be some of the-

Patrick: [00:03:31] The checklist.

Ali: [00:03:31] Some of the checklist.

The History of CoVenture

Patrick: [00:03:33] With that in mind, can you describe the history of CoVenture and its unique structure and the way that it seems to organically grow into an investment firm that's quite different. It doesn't fit into a single bucket, so maybe describe the firm as it looks today.

Ali: [00:03:47] CoVenture's a firm, our focus is, we build funds in what we call new and emerging asset classes that are propped up by new technology. So, we look for things where technology helped us create a new asset class and then build a fund around it. And the way we got started was first in venture capital. So, we thought venture capital was and continues to be, sort of a little ridiculous of an asset class. So, the way the venture capital model works is, you find a couple of people, they put 50 million dollars together and then they give a million dollars at a time to either a couple of kids who can code or a couple of people who can't code but might know the industry. And that just always felt ridiculous. Everyone's like, "Oh, wow. Seed investing isn't really working." Like, "No. Of course not." How is that a good strategy?

And so, what we did, is we said, okay, so what are sort of the main reasons seed companies don't get to a series A. And one of the reasons is they never build their software, they never get to market. And just said, "Okay. So, we're going to actually help the companies we invest in build software to make sure they actually get out to market." And the second reason is they don't find customers. These are not very complicated reasons but those are the two main ones. And one of the reasons that these companies don't get to their customers is the founders don't often know anything about the industry they're going into. So if you look at a tech start-up that's going after the elderly care space, how often are the founders actually from the elderly care industry. If you're looking at companies that are building businesses and financial services, what percent of those tech companies or tech starts are actually founded by founders who've worked in financial services? And god forbid they ever are, the likelihood they ever build the software is low. So we said, we're going to just find founders with domain expertise who work in those industries. Build software for those companies and help them get to market. And then help them recruit their internal team. And that was the first business. And it's gone incredibly well-

And one of the reasons that these companies don't get to their customers is the founders don't often know anything about the industry they're going into.

Patrick: [00:05:26] How would that work, so what was the specific trade that was being made?

Ali: [00:05:29] You know a lot about financial services, about asset management. If you came to us and said, "I want to start a company in the healthcare space." We'd say, "No way." But if you're like, "Look, I've got this tech-enabled solution for the asset management world, and I believe I'm the right person to build it. Here's, by the way, 10 people who are going to be my customers. Four of them on my podcast already, feel free to call them." We'd say, "Great, what do you want to build? Let's work with you to figure out what you need to build to prove product-market fit." And then for anywhere between five to seven percent of the company, we'll build your initial product and then help you recruit a technology team. And if I said, "Hey, who do you think your first technical hire needs to be?" You might not know. If you go to a VC firm they'll say, "Well, you should really have a technical co-founder." What does that mean? Is that a CTO, a VP of engineering, a head of product, a project manager, a project administrator, a lead engineer? And so, we want to help our companies, A, bet to market and figure out, B, what type of team they should really have. And then we'll also invest anywhere between 25, 50, $200,000 of cash. And then if you need more than that help to put together the round.

Patrick: [00:06:30] And how did that all start? So, you started ridiculously young, so maybe tell that quick story about how this was seeded itself.

Ali: [00:06:36] So, I'd done a start-up my freshman year in college and after that, I was doing consulting. And really, the consulting was anytime anyone needed anything I told them that I was an expert at it. And then I'd go hire people who were and sub-contract out the work. So, it's very, very fancy. Actually, the first time I landed a contract with a big company I got fired after two weeks. After I sent my first billing because I was billing $100 an hour. I was like, "Wow, this is amazing." They're like, "That is way too low." And then they're like, "Wait, he's 20?" And so, that was not so good. But eventually, I made enough money where I could start making these really, really time angel investments. And I'd go to founders, and I'd say, "Hey, here's $20,000." And they'd say, "This is great, I'll give you a quarter percent of my company for that. By the way, do you know anyone who could build the actual app? Or could you build the app for me?" And so, I realized that it was actually easier to raise capital than it was to find someone to help them build a product. And their only other options were, give 30% of the company to somebody that they just met at a meet-up, hire a development firm that had completely misaligned interests, or raise enough money where they could pay someone a ridiculous amount to be their CTO. And they also often didn't know what a CTO. So, that was really how we got started is we hired a bunch of engineers. We started building software for equity. And then right after that, we approached two guys. So one's a guy named Thatcher Bell. And Thatcher's spoke in one of my classes at Cornell. And Thatcher's one of those alumni who would come back to school and all the undergrads would be like, "Awe, man. I want to be like him one day."

And the other guy was Mike Beller. And Mike was actually my best friend's dad. And he was one of those people that I would always go to and ask for advice. And I went to both of them, I said, "Look, we've known each other for a while. I'd love if you both worked with us a day a week. And I'll pay you each a day a week because I can't afford to pay more than that but after a year if it goes well, you guys should both join, and we'll go raise a fund." And I didn't have the resume or the background to raise a fund, but both of them did. Thatcher's a real VC, Mike had taken a company public. They were real guys. So after a year, Thatcher kind of recruited Mike. Mike kind of recruited Thatcher. And I was just the lucky guy in the middle. Fine for me. And we raised a few million dollars. Only three, but the way we raised it is, we went to a guy who is sort of a famous venture capitalist. And I said, "Hey, if we raised 2.975 million will you be our last $25,000 check?" And he said, "Sure." I was like, "Great, you're in." So then I used his name to go get everyone else and it was awesome. And so that's how we kind of got into venture.

Then we invested in this company called ProducePay. And ProducePay was founded by a guy named Pablo Borquez. And Pablo's a fourth-generation farmer from Mexico. And he realized that his family, and many other families who had farms, had this huge cash bottle nectar in the harvest. And the reason is, his family would literally go from 300 full-time employees to 2400 during the harvest. The whole harvest was 45 days and the first revenues they got were on day 50. And so, what would use to happen is the distributor he worked with in the US would send him advances when they received the produce. But even that would take 15 to 20 days, so it wasn't a real solution. He came to us, he said, "Look, if I build inventory technology, I'll allow a farmer to go into the website and say, I have $100 of grapes and I just sent it to a big distributor in the US. As soon as the distributor says they received it, I can buy it for 40% of its market value. And then take a commission when it's sold." And we build the initial technology, we invested capital. And then he said, "Hey, can you provide me debt financing so I could actually fund these asset pools." And so, we went out to our LP's and we said, "Look, we think this is a great piece of paper. We think we can get a high yield on it. And we don't think it's riskier than anything else, we just think it's new and different." Two and a half years later I think we've financed hundreds of millions of dollars of produce. ProducePay probably is one of the most important businesses to the agriculture world in which is absurd. I never thought I'd own tens of millions of dollars watermelons in any given year, but that's what my life's like now. And I turned this into a lending business. So, okay, this story's coming along.

So we had a venture capital business and a lending business, and we looked at ourselves and said, "What are we?" And realized that what we really loved to do is find asset classes that we could get a really good return because they were just new and hadn't really existed before. So no one really had perishable produce financing before, but that was why we were getting a high yield. And we said, "There are so many cool assets out there that no one really knows how to value." How do you value an Airbnb account? How do you put a multiple on that? How do you value the reviews? That person has really good reviews, there's barriers to entry, they have a really great picture. How do you do that? How do you value an Instagram account? How much is an Instagram account worth? How much value do you put on a like, or an impression? These aren't overly complicated, but they're probably mispriced because no one's tried it and it hasn't gotten to the mean yet.

And so, where we are now in CoVenture is we have three businesses. We have venture capital, we have lending and we also have a cryptocurrency index fund. We felt like based on the firm's DNA, we had to have one. It's a new asset class built on the back of technology. We think it's interesting for a million reasons that have probably already been on this podcast. And reasons you've heard, and happy to go into it. And that really became just an index fund. And we said, "Look, I really couldn't tell you why Ripple's on a tear this week. Rumors that it might be on Coinbase or that's the idea that they had." But I think it's really hard for anyone to say that they know what the future is. And so we said, "Look, it's just going to be an index fund. It's going to be a basket of the top 15." Market cap waited and re-balanced every two weeks. And so that's sort of all of CoVenture in a nutshell.

Patrick: [00:11:45] It sounds like it's something that's going to change a lot in the coming years as new technology enables new opportunities.

Ali: [00:11:50] Yeah, totally. Right, and I think that our goal is to continue to add one or two asset classes a year. And again, we're going to go through the same analysis around our investment philosophy, which is, okay, so why does this newly exist? Do we understand why no one knows how to price it? Do we think that our team's DNA, being sort of in-between technology and finance allows us to underwrite it differently than anyone else can? We have a really amazing LP base that allows us to be flexible and do these weird, niche, interesting things because they like that we're getting a really high return because it's a little smaller in the beginning and different, and no one knows how to do it. And then, does it build barriers to entry over time? And if it checks off those boxes, we'll probably get into it.

Cost of Capital Risk and Fee Structures

Patrick: [00:12:29] One of the things that you've written a bit about that I was most interested in reading your stuff on the train on the way into the city today was, this big philosophical discussion of cost of capital risk. How good we are via technology at underwriting price and risk. So maybe, if you could begin to sketch out what that framework is. Why you wrote about it, and why you're so interested in cost of capital as a topic.

Ali: [00:12:54] There's a lot of reason I'm interested in cost of capital. One, it depends on how much I can originate. I'll give you one place to start, which is, I think the cost of capital in venture capital is ridiculous. I think it's absurd that we were supposed to return three X our capital in 2007. Three X our capital in 2010. Three X our capital in 2013. Three X our capital now, when the markets have been different in each of those years. But no matter what, we're all supposed to return three X. That sort of sounds absurd. The other thing that sounds absurd to me is that every VC fund has the same cost of capital. Where it's like, your first round capital said, "Ali, I'll let you be an LP and we give you two X your money." And then someone firm I've never heard of said, "Ali, I'm going to let you be an LP and I'm going to return four X your money." I'd still give it to first round because the likelihood I get two X my money back's pretty high. Yet, everyone says they need to return three X. It's just this crazy thing. And what's also crazy to me is, I think there are firms out there who everyone yells at them for investing at really high valuations. They just build a better product. They just have a lower cost of capital. If I convince by LP base that all I had to do was return one and a half X their money on my VC fund, I would have an unfair product because I would be able to go to a company, invest at a higher valuation than all the other competitors and still do what I needed to do to raise my next fund. That's a differentiated product, that's really cool.

Patrick: [00:14:13] One of the things you wrote quite a bit about is, we were talking before we started recording just now was, that it's kind of wild how similar the fee structures are for asset managers, for venture capitalists given the dispersion of skill. And that maybe that should change, that's one way of thinking about it. The other thing you wrote about is this idea of the relationship between return and risk, where the more uncertainty there is, the more risk there is, the higher the return should be for investors to compensate them for that. But that as a species, we're just getting better and better and predicting the future, at underwriting risk, at quantifying risk. And therefore, maybe the returns that we should from every asset class should be ratcheted down accordingly.

Ali: [00:15:00] Yeah, I mean, if you were to take a really, the world's perfect and everything's linear view. You could say, "You have fund A, and fund A starts in the year null. And so they should have the highest cost of capital that year." Then in year one they should have a lower cost of capital, in year two they should have a lower cost of capital still. And then you could say, "Okay, so that's obvious because every single year they're going to get better and better at predicting how they should make investments, which makes them less risky. And then their cost of capital should come down." So the fact that Sequoia would ever have the same cost of capital as a new entrant makes no sense. Sequoia should just have a lower cost of capital because it's less risky to give them money.

I think you also see that in lending. I think right now, one of the biggest struggles we have when making investments in our lending business is we'll go to a platform that's originating new, cool, loans. We think it's a great risk profile, but one, the founder went online and read in the Wall Street Journal that people are getting seven to eight percent yield and that's really good. And so now they think that they're going to be able to get that. The second thing is, they don't really appreciate the unknown unknowns. One of the things that really blows our mind is, you'll have either funds that go to them and say, "Wow, I think that you're new, but I'm willing to give you a cheap cost of capital because I think over time we're going to figure this out. And I think I'm going to get paid in warrants, so that'll be my new, interesting way of getting paid for having taken the risk." I think that's a fallacy. The reason I think that's a fallacy is, often the debt and the equity and inversely interesting. So, if the debt is interesting it means it's probably going to say interesting because the yield will stay higher over time. Because the loan book doesn't get so big that it takes in entrants with low cost of capital, like the Apollo's and the Blackstone's of the world, et cetera. However, if that happens, if the debt stays interesting, the equity will never appreciate in value. If the equity ever appreciates in value, the loan book's going to get so big that that cost of capital that you were charging, you're still going to get refinanced out of. And do the warrants really make up for it? I don't know what coverage they're charging, or what warrant coverage they're getting, but it's probably not enough to make up for it. So, I think that it's crazy that cost of capital always stays static. And then they say, "Okay, so I'm going to make you a three-year loan, and the price of your debt each year will be the same, even though in year three it probably should be..." I don't know.

Thoughts on VC Landscape

Patrick: [00:17:03] So, let's tackle each of these buckets. Probably spending the least time on crypto, but we'll touch on that as well. We'll start with VC, so if VC was a country and you were the president and you're giving a state of union address about VC. You've made some key points already, but more specifically to the spot that we sit in today at the beginning of 2018, thinking about things like, the opportunity set, the supply, and demand of capital, the valuations that are being paid, those sorts of things. How would you sum up, kind of from your view, meeting with early-stage entrepreneurs, where we are absolute and relative to the recent past?

Ali: [00:17:39] I'd start with I think a few key issues that we need to resolve in the next year. The first is, there are two comments that everyone agrees with. But the two comments don't agree with each other. One of the comments is, you should really stick to your knitting. If you're a seed-stage fund, you should be really good at steed. Don't grow too quickly, get really good at that, and don't do things outside your core competency. If you're a series A fund, the same fund. If you're a series B fund, the same. The second thing that people say that everyone agrees with is, the only way to make money is to have a contrarian view that is correct. So to believe in something that no one else believes in, but it turns out you are right. Now, if you're a seed fund that's sticking to your knitting and you shouldn't do any other stage, but you're also investing in contrarian things. Who's going to follow onto that round? Because you can't. So now, the game is called, have a contrarian view that it turns out you're right about. And then within 12 months convince all the series A funds that they should change their view and fund the company. That's sort of weird. And so what it turns into, is every seed fund listens to all the series A funds and says, "Oh, wow. So that's what you're invested in now?" Or like, "Oh, you all like AI, or you all like elderly care? Insurance tech", whatever themes that have been in the past. Okay, now we're going to go, "Where are your scout teams?" So we're going to go find those companies and send them to you so you can make all the good stuff happen. I think that's a really big problem.

And I think the other problem that probably people have talked a lot about is, the terminology of all these rounds is probably wrong. Because what happened was, you had a bunch of seed funds. And the seed funds were either bad and disappeared, or they were good and the manager went out to the LP's and said, "Now I want to raise a bigger fund." And the LP's said, "Good, I'm willing to give you more money, but you have to keep doing the same thing you were doing." Because I already underwrote that. And then, the GP was like, "Yeah, I promise." And then they had more money, and so they had to write bigger cheques. And so, of course, they kind of moved up the stack. And so, if you were to write a list on Excel or something of all the rounds that were done in New York that were under a million dollars in size but led by an institutional VC fund like a seed fund. I bet you it would be an incredibly shortlist, because all those seed funds do what series A was supposed to do. The other is, all these VCs accidentally subscribe to matter mark and saw a couple of bloggers write, "I think that you need a $20,000 monthly recurring revenue and 15% month over month growth to raise a round." And they all said, "Okay, that's what you need to raise a round. We're only going to invest in companies that do that." Not realizing that every company should be underwritten differently. And I think we need a new framework for thinking about how all the different rounds have to happen.

When we do what's now called a pre-seed round, we say, "Look, we're going to give you money and the only thing you're supposed to do with this money is figure out if you're creating customer value." People often think revenue means customer value, but I'll give you a reason why that's not true. If you and I went to lunch and we had a really crappy lunch, we would still pay the bill. I would, I don't know if you would. But that'd be a dick move if you didn't. So, I'd pay the bill. That doesn't mean there was customer value created. The KPI to track is, did we finish everything on our plates? Did we take a box home? Did we come back? So, we say, "Look, prove customer value, because that'll give you some indication of what you're LTV's going to be, your customer lifetime value's going to be." What's crazy is that seed funds expect those businesses to already be growing, which implies they've been using their money to acquire customers. If you don't have a hypothesis of what your lifetime value of the customer's going to be, how are you supposed to know how to acquire them? If your customer ends up being worth 100,000 to you, you can hire a sales team. If they're worth $2000, you have to do marketing and ad campaigns. Why would you try that until you know you're available menu of cost-effective options? So I think that that's when you do a seed round and the series A is to see if any of this cost to customer acquisition channel scale. I think we all have to get on the same page on that.

Patrick: [00:21:16] Is it fair to summarize what you just said as sort of, I've heard this from a few, Andy Ratcliffe's one that comes to mind. Where the first thing is the value hypothesis. So this would be kind of your qualified version of a value hypothesis. And then the growth hypothesis is something else that we can come back to. Is that a fair distinction?

Ali: [00:21:32] Yeah, I think you should know what round you are in and decide which hypothesis you're trying to solve for, and not take the two, or three blogs everyone uses to figure out if they should be funding a company that seriously.

Patrick: [00:21:43] Describe a little bit your actual process, your investment process on the VC side specifically. So, is it all pre-seed? Which stages do you get involved in? And then, let's get into how you evaluate opportunities in industries and addressable markets.

Ali: [00:21:58] So, primarily pre-seed on the venture side. Although, we do equity investments and lending, and I'll explain how we think about those in a second. And the way we do the diligence is one, are you a founder who knows everything about your space? We don't want to back some really smart HBS kid who read a study about a space and now is going to start a company in it. We want someone who actually knows the customers, is sold into it, et cetera.

Patrick: [00:22:17] Can you give a recent example of somebody like that, and what the industry was?

Ali: [00:22:21] Yeah, so we're invested in a company called Gallium based out of Georgia. And the woman has a Stanford PhD, her name's Gail. And she was doing consulting for heavy equipment dealerships. And she realized that heavy equipment dealerships are terrible at claiming warranties, because what they usually do is, they send some individual out into the field. And they write down the 16 character serial number of a Caterpillar tractor, and then 14 other things on a piece of paper. Take a picture of it, email it to somebody. Bottom line, the warranty almost always gets denied. So she's built an app that helps them better capture that data and she saves $300,000 a year per dealership. That's just a person who's solving a problem that no one in Silicon Valley gives a rats ass about, right? But she just knows the customer and she can go in with her stupid iOS app, and sell the shit out of it. That's the type of business and person we love to back.

So, someone like that comes in and we say, "That seems great, you're the right type of founder. We understand that what you want to build will help prove customer value. And if customer value is there, it'll be there for a lot of people." And then what we do is, we try to sell the product ourselves. And I'm probably a little narcissistic in saying this, but I'm kind of convinced that I'll be better than the 20th employee that every one of our companies hires. And if the founder can't teach me how to sell the product, or if I can't sell the product to somebody, it means their 20th employee won't be able to either. Either because the founder can't teach me how to do it, or no one wants it. And so, if I, in the process, cannot help land a sale. Maybe farm money, I don't happen to have a bunch of farmers on my Rolodex. But I know someone at Rabobank, right. And they do. Right, so I'm sure I could figure it out. And that's part of the process that I think a lot of other people don't run. The other part is because we build products with the founders, we make follow on decisions better. So, a lot of VC's will say, "I make follow on decisions well because I'm on the board and I get information rights." I mean, you've worked at a company. The employees at a company just know different stuff than the board does. And our team working hand in hand with the founders just gives us certain insights.

If the founder can't teach me how to sell the product, or if I can't sell the product to somebody, it means their 20th employee won't be able to either. Either because the founder can't teach me how to do it, or no one wants it.

Patrick: [00:24:15] Is it still that software component as a key part of-

Ali: [00:24:19] Of the venture business, absolutely.

Patrick: [00:24:20] Yeah, is it in every case?

Ali: [00:24:22] Almost every case. There are two companies that we've invested in where it wasn't. One, the founder had sold a business for 100 million dollars that we had backed before. And we were like, "We'll do anything he does." The other was in the, I haven't met a lot of companies in the Blockchain space, but it was a crypto company that now is a top 15 crypto. And we can't believe that happened. I have no idea if it should be that valuable, but it is. And so it's great.

Patrick: [00:24:45] How does that development effort actually work? Do you have a full-time staff of developers somewhere?

Ali: [00:24:50] Yeah, so we have engineers in both New York and Canada. But we have an office in Ottawa, and I think Ottawa's one of the best places you can recruit engineers. Partly because you have University of Ottawa and Carlton there. And partly because you just don't have the same companies recruiting the best ones. When I recruit someone in New York I got to convince them they shouldn't work at Palantir, or Facebook, or Twitter, or Google. But the other thing is, we actually have a really good time recruiting engineers. Because think about what the job application is. Hey, you can either go work at a big tech company and work on the same thing for a year. Or you can come to CoVenture and co-found a company every six months. And if you happen to like the company just go join as the co-founder. It's a pretty cool job for an engineer.

Patrick: [00:25:25] Very.

Ali: [00:25:25] And so, I think that's why we're able to attract really good talent. But yeah, so that's where the software developments done, and it's been a really good experience.

Patrick: [00:25:32] So back to the process again. You had a really interesting checklist at the beginning for the investment philosophy, sort of things that you're looking for really in an asset class that will make it a somewhere you can have a sustainable edge. Are there other checklists like items, other than somebody, the one I love is, someone with deep domain expertise in an industry that's maybe less interesting to Silicon Valley VC's. Are there other things that you look for in the early stage diligence process that are must-haves or close to must-haves?

Ali: [00:26:02] I think high-velocity founders are really important.

Patrick: [00:26:04] What does that mean?

Ali: [00:26:05] So, the type of person who, they're making progress during the diligence process. There's nothing that gets us more excited than when we're talking to a company and they say, "By the way, I landed this sale. By the way, I did this." The other thing is founders who set expectations of what success is early on. There's a guy named Jordan Bettman, who's got his own VC fund now. And he gave me this advice, which is, he said, "Every time I invest in a founder, the very next board meeting we write a deck for what the next rounds deck is going to be. And that becomes what we have to get to with this capital. We look for founders who are very focused on, what do I have to do to get to the next influxion point. And my resource to get there. And is there some sort of validation that we believe the business is more valuable because they've gotten to that next influxion point?"

There are all the other things, like barriers to entry, and are they building moats, and do they have pricing power? But I think at the end of the day, it really just comes to, is this a company that's outside of the obvious solutions of Silicon Valley? And are we able to build a business that's sustainable because of that? And again, probably most of my best friends live in San Francisco and the Bay area, so they're going to text me after this and say I'm an idiot. But I think the tech world has this problem where we go out and we say, "We all think that we're really smart and we think that the rest of the world's really dumb. And so, why don't we just build apps to make their lives more like ours." And it's sort of crazy. And what you end up doing is, you end up building products at the end that are built with judgment at their core. And when you find founders that are building products for themselves and their friends, you end up building products with empathy at their core instead. And that empathy ends up translating into features and functions that understand the seemingly unpragmatic nuances of a given industry. You and I would look at how a hospital works and be like, "God, what a bunch of idiots." They're probably not a bunch of idiots. Most of them went to med school, they're genuinely smart. Sure, not everything's perfect but they're more or less doing their best. You have to understand why the hospital's build the way it is. And I think that just being a couple of really smart kids who went to an Ivy League school and studied CS, you don't understand how a hospital works.

When you find founders that are building products for themselves and their friends, you end up building products with empathy at their core instead. And that empathy ends up translating into features and functions that understand the seemingly unpragmatic nuances of a given industry.

Judgment vs Empathy

Patrick: [00:28:01] When you say judgment versus empathy at the core of a product, maybe just describe that in a little bit more detail. It's an interesting framework.

Ali: [00:28:08] Yeah, judgment is like-

Patrick: [00:28:09] I know how to do this better than you.

Ali: [00:28:11] ... "Hey, wow. I think that rating agencies are stupid because they're hired by the person who's underwriting the loans that are originating." Of course that's dumb. I read the Big Short, and I'm a good fast reader and so I read it twice. And so, now I know how it works. I'm going to build a company that solves that. Okay, that's really tricky. And you would look at some kid in Silicon Valley being like, "Okay, I'm going to solve this obviously stupid problem." Or like, "By the way, remittances." Okay, this is a great example. Everyone's like, "Okay, the Blockchain is going to solve the remittance problem." Maybe, you still have two governments talking to each other. You still have this crazy process of trying to clear payments. Everyone in Silicon Valley thought, "Okay, we have a technology solution, of course that's going to solve this really slow and expensive process." I think someone from financial services, or who had worked at a bank, was like, "Whoa, there's politics involved." And this isn't just a technology problem, this is a switching cost problem. This is a political problem. This is people going to lose their jobs problem. I think that understanding for those extra complications takes empathy.

Patrick: [00:29:10] Got it, so empathy is more solving one's own problem or one's friends problem. Back to the industry domain expertise, you're intimately familiar with what the problem actually is and how things work.

Ali: [00:29:20] I'm going to be really annoying with my nomenclature, I think that's sympathy. Empathy is imagining yourself in the other person's shoes and understanding that problem as a first-party even. Not just having heard about it or read about it and saying I can list the problems. By the way, when you're talking to someone who does asset management, you just know. You and I were talking like, "It's the end of the year, we got to make sure all of our LP's know what's going on." I empathize with that. That is brutal, not because you don't love your LP's but you're like, "I want to make sure I'm getting all the right information."

Empathy is imagining yourself in the other person's shoes and understanding that problem as a first-party even. Not just having heard about it or read about it and saying I can list the problems

Raising Capital

Patrick: [00:29:47] So let's talk about LP's for a second. You started-

Ali: [00:29:50] I love all them.

Patrick: [00:29:51] ... You started very young and very small. I think you said you had 396,000. Maybe describe that.

Ali: [00:29:57] We went out and raised any dollar we could, we raised $396,000. We were trying to raise 395, we raised 396 because my little in my fraternity gave me $1000 on Venmo. And I ended up giving him his first distribution back on Venmo, and I was like, "Crap, how do I put this on the books?" And now he works at CoVenture, by the way. So it was pretty awesome. So, he worked at an investment bank and this was an investment bank that when I was college I didn't even get an interview for. But he said that now when they go back to universities on their slide, like exit opportunities after the investment bank, they have our logo. Oh yeah, it was like, "You can go into venture capital after the bank." And like, "Man, that's the best thing that ever happened to CoVenture." That's our current highlight.

Patrick: [00:30:31] So, you've dealt with a lot of LP's because you had many of them early on. I know you still have a ton of LP's out there. What have you learned about, two things; how to best interact with those LP's and also for venture capital specifically, this is something that I've struggled with thinking about. Who should and should not be a venture capital investor? If you've had negative experiences generically, what have been the reasons for that? And maybe reasons you might avoid similar LP's in the future.

Ali: [00:31:00] So, we've gotten really lucky. We've actually had an incredible LP base. So, any answer I give you on what makes someone not a good LP would be sort of what I could imagine. We don't deserve the LP's we have. And what we've done is, so we have about 180 either individuals fund-to-funds or something other across our various funds. They become a huge source of deal flow because a lot of them are from the tech world. They've either started companies, they've started VC firms. Some of them have been presidents of banks, some of them have run private, like our equity firms. So, out of 180 people, we probably get 1000 deals a year just from them. And then we've actually built communities with an LP. So about every two months, we have one of our LP's give a talk to the rest of them about a new topic. How do buy a sports team? Introduction to the Blockchain. What was the financial crisis like from the executive committee of a bank.

And so, we've created this cool community that keeps us top mind. A lot of it is just playing offense all the time with information. Hey, here's a company, it just had this announcement. Here are ways you can help make those ask's really, really specific. And in terms of the people who shouldn't be investing in venture, probably most of the world. It's a liquid, it's scary. We have a crypto fund and we happen to think everyone should have 25 to 100 BPS, or their assets in crypto. Maybe that's right, maybe it's wrong. But the minute you're putting more than that in, any speculative asset is scary. And if you aren't prepared to lose it. Also, if you are taking a swing where you think, "This is going to be the only fund I'm going to invest in." That's probably not the right way to think about being an LP in a fund.

So, the worst thing you can do for a VC firm, or a VC manager, is say, "I'm going to give you capital. You have to deploy this capital within three years. And I have to get three X my money back, or I'll never invest with you again." And the reason I say that is, some years it just sucks to be a VC. And some years it's going to be hard to find deals. And I think you had Sheel on the last week's podcast, he said something really good, which is, "I might just take a really long time to deploy the capital and you guys have to be okay with that." I think having that steady capital base that says, "Look, we're going to bet on you for three funds. And in ten years you're going to hit a home run. Don't do anything stupid just because this is the fund that you feel like is going to be make or break."

Imagine if you were a baseball coach and you told this kid who was on your team, you said, "Look, all the scouts are here. You have to have a game, they're only going to see you for one game. You have to have such an amazing game that they're going to draft you in the MLB." You have most kids go up there and try to hit three home runs in the came not to do very well. But if they said, "Look, you're going to be the starter for this whole season. The scouts are going to be at every single game that you play for 30 games. Just be you." You're going to have a great season. You have to sort of put someone with a capital base to succeed, where they're not like, "Every bet is all or nothing and if I don't return five X I won't get my capital back." So it's sort of building long term relationships with the LP's.

Time of Biggest Risk

Patrick: [00:33:39] Couple of more questions before we leave venture capital and talk for a bit about lending, which is something we really haven't talked about at all in this podcast. So I'm excited to spend some time on that. The first is a question I've always... I'll close with my usual question, which is, what's the kindest thing that anyone's ever done for you? But I want to try to introduce a couple of other questions that I ask everybody. And we'll try a few out and see if they work or not. So, the one I'm going to try for the first time with you is to ask, what time or what point in your career, or just life, you felt like you've put the most personally at risk. So, you talked about risk earlier as this really important part of the investing equation. In my world, in the public markets, the risk is this over-quantified standard deviation, right? Which is kind of a silly measure of risk. So what is the point in your career or life that you have felt the most at risk or exposed yourself?

Ali: [00:34:32] Every single day I am exposed to more risk because my opportunity cost grows more. So on day null, there's less risk because you have almost no opportunity cost. I didn't have a fund, so my worst-case scenario is I didn't have funds the next day. So I can take some amount of risk. By the way, when you're underwriting a manager, you should try to figure out how much personal risk they have. And one way people do that, it's, oh, how much is the GP committed to the fund? I hope it's one, to two, to three percent of the fund. That's part of it, but it's also how much do they have to lose from their reputation? So, I would say we've now built a firm where, look, we've made money for people. The returns I think have been good enough where we're having people stay with us and grow with us. So every day thereafter, we have greater risk and I personally have greater risk because I'm getting more and more to lose. I think that's actually a competitive advantage to newer entrants. It's just like when a large company won't go into a new space because they have more to lose. Microsoft can't just suddenly embrace the Blockchain because they have a business that they might hinder. That allows a start-up with nothing to lose to go after it. The larger the start-up becomes, all of a sudden becomes a big company, now they have a lot to lose. So, I would say that later today I'll be incurring more risks than I will right now, and tomorrow more risks than today.

Patrick: [00:35:44] What about emotionally. You said empathy versus sympathy before. Surely there must be a time before today as the point of highest risk for you, almost formulaically or objectively. Where, subjectively and emotionally you felt, I keep using this word exposed because that's the word, I was having a conversation with my friend Bill about this, and that's the word when he used that word to me that actually got the good answers out of me. Was when I felt the most kind of nervous or exposed. What about that way of thinking about it, more from an emotional standpoint?

Ali: [00:36:12] I think when we put our name behind a thesis and venture that was really weird. I think that when we first started, everyone wanted to find the next app developer who was obsessed with the design and had this single page scroll website. It was like, "All right these app kids are going to build every company that changed the world." And we were the curmudgeons who were like, "Yeah, we actually don't think you have to have a technical founder. And we're going to put our name behind that. And we're going to go back people who, god forbid they're not in their 20s and app developers. We're going to go back people in their late 30s who have been industry executives before. And we're going to build a tech company." There were VC's who were angry with us and wouldn't meet with us. It was really scary to have my name associated with that because they were like, "Ali Hamed, in my inbox for a stupid idea. Next. Never want to talk to that guy again." It was really scary to get those intros and try to introduce something that I knew 20% of people were going to think was awesome and 80% of people are going to think is idiots. The other part that I felt most exposed was, when we started our crypto fund, honestly. Because you have to understand, at least half of our LP's have made money with us doing asset back lending. So I went from explaining why a low LTV over collateralized loan with great cover and packages, all the assets were trapped. It's like, "Hey, so that's the first 30 minutes, I'm going to get you 13, 14, 15, net. So have you ever head of ether?" That is a weird conversation to switch to. And they were like, "I trusted you." We had a few people redeem, because we were doing crypto. They're like, "I can't trust you to do lending if you're also going to do this Bitcoin thing. Larry Fink thinks it's an index on the bad people". You know like Oh god. So those are probably the main two.

Investing in Crypto

Patrick: [00:37:55] So, just because of the answer, let's just touch on crypto for a minute and then we'll get to lending. So, why? So, that seems like a reasonable objection from LP's. I sort of feel that way about crypto on half the days. So, why? Why the need to do crypto?

Ali: [00:38:09] We really believe in it as an asset class. And I think that people are probably more euphoric than they really should be right now. So let me start with a couple bear cases. The first bear case, and my partner talks about this all the time. He goes, "Look, it's really ironic and kind of sad that the Blockchain was supposed to discern me the banking system. But the first company we all think about when we think about Bitcoin is Coinbase. And that's an intermediary that charges a point and a half in and a point and a half out." So, that didn't work. The other thing is, people say things like, "Oh, man. The government couldn't shut it down." If the US government tells me it's illegal to own Bitcoin, I'm probably not going to own it. That comes from a guy who's got a business in it. Jail sounds like it blows. And I just don't want to go to jail. And I think that's actually a powerful concept.

And it's probably not going to be a currency. It is just stupid for a government to allow something to compete with its own currency. If I wanted to think of one way to revolt against the government, it would be to debase its currency. I think governments kind of have a clue. But there are a couple of things that are incredibly interesting about it. The first is, we think about this trustless system. And people often think about the US dollar and banks in the US and say, "It really sucks that Bank of America has all my money and I have to trust them, but I'm willing to deal with it." I use Bank of America and I think it's great. It's a fine business. And if I give them $1000 and I go back the next day, they'll probably say I have $1000. But if you're in Libya, I have half my family in Libya. If you're in Libya and you're going to the regional bank of Tripoli, and you give the regional bank of Tripoli $1000 and you go back the next day and say, "No, you gave me $990." Who do you complain to? That's actually really tricky. So, that was one thing that I thought was interesting about the system. But the other is, if you think about Bitcoin as a store value, it's probably a pretty good one. If you were to go down a list of what makes something good store value. You know, It's volatility, and Bitcoin sucks at volatility. Its portability, I think Bitcoin crushes gold at portability. I've never tried crossing a border with $10,000 of gold in my pocket, but as a guy named Ali Hamad, I can't imagine that's a super fun experience.

Patrick: [00:39:57] Yes.

Ali: [00:39:57] So, if I was a Syrian refugee, I'd probably rather be traveling with my private key than a pack of gold. So, if you keep going down the list. Acceptability, the restaurant that we didn't pay the bill at because we didn't like the food, they're going to accept Bitcoin before they accept gold. Can you imagine taking out a piece of gold and saying, "Here's my scale. I'm going to shave off a sliver of it, I'm going to put it on the scale, and I promise my scale's not rigged." So we're really bullish that Bitcoin could be a real store value.

Patrick: [00:40:23] Have you ever seen an actual story, a story that you can corroborate, of that kind of use case? Because everyone talks about this. Everyone talks about Syrian refugees or Venezuelan citizens, or hyperinflationary down the south citizens who could use this to mitigate that problem. I have not gone looking hard, but I've never actually talked to anyone that knows anyone that's done any of this.

Ali: [00:40:47] I think most of the people you're talking to don't live in Japan and South Korea.

Patrick: [00:40:50] Totally true, but I have talked to the people in those areas. There are really small examples of this. So, I mentioned on the podcast one time, I know a guy, a Chinese national who uses it all the time for a very real use case. But the amounts are very small, relative to the very speculative value of the total cryptocurrency market cap.

Ali: [00:41:09] Yeah, so look, I completely agree with that point, which is, we're probably at a place where everyone sort of like, "All right, we think it's going to be a big deal." And the amount people think it's going to be a big deal compared to the big deal it is right now is probably out of whack. So, I totally agree. I think that there are probably people in South Korea who do that more. I think we love talking about Venezuela because it's on the news all the time. I don't think there's a lot of people in Venezuela being like, "Oh, thank god I have Bitcoin." So, I sort of agree with that. And I think the places where you're going to need it the most is going to be the places that it's hardest to get. So completely agree, I think that's in the bare case column, which is, the utility of it just isn't there compared to the speculation. I have no idea what's going to happen in 2018 or 19. I just think by 2025 it's going to be better. And I do think that the use case with catch up.

Patrick: [00:41:57] Back to your investment philosophy checklist. The reasons why you think it's a good place for you personally to be, you and your firm personally to be versus just generically the bulk case generically. What are those reasons?

Ali: [00:42:09] The way we think about our firm's core competency is we build funds in emerging asset classes built on the back of new technology. And we have to be amazing at doing that. And if we were to think about what skill set is required to manage a crypto fund. We think it's engineering, but you have to understand that's for the technology. Underwrite the technology. I think you have to take sort of a venture-ish view of, do I believe it'll get the network effects? Do I believe it'll build barriers to entry? To I believe that it'll be adoption. One of the guys on our investment committees who run a trading desk at Goldman. Can you actually trade this stuff? So I think it takes this cross-disciplinary approach of being able to actually try to understand it and invest it. And we felt like there was a good place.

The other thing is, when we got started, frankly, we just didn't think there were a lot of professional money managers managing the capital. The first LPs I got for some of these funds have European waterfalls. They look like venture fund docs but were trading crypto. And I was like, "Do you have side pockets for forks?" What if someone wants to redeem and some if it's a liquid, have you thought about that? They're like, "Oh, well no one's redeeming right now." I'm like, "Okay. That's sort of weird. So I can redeem my whole now, and you're in an ICO?" There were really small things were I was like, "All right, we're better than that."

Patrick: [00:43:20] Just bring professionalism to the space.

Ali: [00:43:22] Bring professionalism, right. Know how to write a freaking hedge fund doc. Know that there's a difference. Know how to mark your NAV profession- stuff like that.

Patrick: [00:43:29] Is there anything in particular that excites you most. So you mentioned the year 2025, or some longer-dated period when crypto will have improved a lot and be really having a big impact. Is there a use case, or a specific currency, or an idea that has you most intrigued or excited about?

Ali: [00:43:44] It's probably still store value. I have a hard time getting excited about store value because for store value to be more meaningful it means something bad in the world probably happened. So, it's a little bit weird to be optimistic about it. If I had to call a utility token, so there's a company called Blockstack. And basically, the whole idea behind Blockstack is, you can build applications without building a back-end or a database where you're storing people's information in an essential place. And I blog on Medium, as you know. I think it's crazy that god forbid, Medium went out of business. I would actually lose all my blogs. That sucks. And I don't think Facebook's going out of business, but oh my god, if Facebook shut down, I lost every picture I'd had. So it is crazy that data is centrally stored. I think what they're doing in terms of saying, "Look, we're actually going to decentralize data. We're going to allow you to store it wherever you want. You can put your data on Google Drive, or Dropbox, or on your local computer. And the web application that you're accessing, it just queries wherever you want it to query from. I think that's interesting. So, of the utilities for tokens, I think that's cool.

The other one, and it's going to be an analogy that you can break down 50 different ways. And so anyone who's listening to this is going to be like, "That's a stupid idea." But I think it illustrates sort of what could be. So let's imagine in 2000 Amazon created Amazon tokens. And they said, "Okay, so the only way to purchase a book on Amazon is with an Amazon token. We're going to issue a million of them." And you went on Amazon and you said, you read a lot. So you said, "Look, the books are cheaper there. I'm willing to go through the hassle of turning my US dollar into an Amazon token and using that token to buy a book." And everyone started doing this. And so, in the year 2016, I think Amazon did a 130 billion dollars of revenue, something like that. And still, the only way to purchase on Amazon was with tokens. If there are only a million still, each token would be worth more than a dollar. I don't know what the velocity would be on Amazon, but let's say they were worth 10 billion dollars in total. And Amazon wanted to raise capital. And they said, "Well it's hard to raise equity and hard to raise debt right now. What if I just issued one percent more tokens? Would anyone be pissed?" And all of a sudden they just raised 100 million dollars with no dilution. So you had equity to raise capital, and debt to raise capital, and then a token financing. A real token financing, not just an ICO with a white paper and a couple of engineers who said, "This is going to be cool, I promise." That's a third asset class, that's really powerful. Now, what you should say back is, "Okay, you never use a token because A, the volatility of the tokens would make them hard to purchase the books. And there's going to be speculation, the hassle going from the dollar of the token would reduce revenues." There are a million reasons that might not work. But there are hypothetical situations where like, "Oh, wait. That might be huge."

New Forms of Lending

Patrick: [00:46:10] Let's talk about lending now, and there was a great story in there, you mentioned the story about watermelon at the beginning. But another story about a firm raising money, kind of talking about the relative merits of a bridge round versus a series A round. And the solution was, well why wouldn't I factor your receivables? You give up less of the company, you spend less cash, everybody wins. I get a great rate of return. Maybe tell that story as a bridge, sorry to use that word, into debt and lending.

Ali: [00:46:36] I do like most venture capitalists. I do like the asset class. But I do like talking trash about it. So this company came to us, and they were doing a million dollars revenue a month. I think they were slightly profitable, and the guy said, "Hey, I need to raise three million dollars really quickly. I mean, I'm raising it on a capped note. It's a convertible note with a 50 million dollar cap." And I looked at the business and said, "Well you have two million and change of receivables, how about I just fact the receivables and you go find a million dollars from someone else. I like your business, but it's going to take me a while to underwrite it. I don't really have to underwrite the receivables in the same way. I'll still underwrite them, I promise, but not in the same way." So, what I'll do is, I'll factor them for some absurd rate. I'm going to charge 5% warrant coverage, so I feel like I have some upside in case this business ever goes well. If you were going to sell six percent of your company now you only have to sell 2.2, 2.1 percent of your company. I just saved you 3.8 percent of your business. What can that buy you? That can buy you a COO, a VP of sales, I don't know. And he goes, "No, no. I'm just trying to raise a convertible note. I don't think my VC's are going to be comfortable with me doing factoring yet. Factoring seems like it's addictive and I don't want to get on the factoring." I'm like, "holy moly. This is absurd. You are not understanding that this is way, way better for you and way, way better for me." And it was one of the first times that we said, "Wow venture capitals really uncreative." And I wonder if you went into Silicon Valley and said, "hey guys, what if you didn't fund a company with venture capital? How would you do it?" And they'd be like, "Oh, venture debt." That's their only other solution to venture capital, the world's bootstrapping with money from another venture capital-backed company. Venture capital and venture debt. And there were no other solutions. That to me felt weird.

Patrick: [00:48:09] And so, obviously you have found a huge opportunity in this space of lending. So, maybe give an overview of this segment of your business and the different kinds of places that it touches today.

Ali: [00:48:21] Our lending business, what we do is, we look for companies. So we look for alternative lending platforms that are using their technology to invent new types of credit. So we're not looking for companies that are basically taking loans that banks used to make offline and putting them online, like unsecured consumer loans or SMB term loans. We're looking for companies that are actually inventing new types of credit. So, ProducePay was a great example. So, when we were doing diligence we called Rabobank, we said, "Hey, are you guys ever going to do this?" And they said, "No way. We could never lend against perishable produce." So they were using technology to actually track the stuff in real-time and invent a new type of product where we could finance it at a really, really attractive yield, without taking any extra risk.

There's another company that we invested in. What they do is, they built scheduling software for large companies. Let's just pretend, it's not a real customer, but let's pretend McDonald's was a customer. So they go to McDonald's and they say, "How do you figure out when your employees are going to come to work?" And they say, "Well, we use a piece of paper in the back room, or an app called When to Work, or something like that." We said, "Use this app instead." And then don't pay your employees every two weeks, instead pay us. We then tell the employee, you can now take your paycheque any day of the week you want instead of on a bi-weekly pay cycle. And so if your rent was due Wednesday but your paycheque wasn't till Friday, you don't have to take a payday loan out anymore. You can just take your paycheque early for a $1.50. And now we're getting a 20 something percent return on McDonald's credit. That's a new type of product that hasn't ever existed before, which by the way has switching costs. And the reason a company like McDonald's would want to use that is, if you were thinking about working at McDonald's or Starbucks. And one would pay you any day of the week you wanted, and one would make you wait two weeks, for a lot of those people, cash flow's a huge, huge issue. And they'll pick McDonald's, maybe even if it's for a little bit less money. And so that's another example of finding companies that are in, I don't know what to call it. Is it payroll finance? I don't know, there's probably a word that will one day be a thing once it's an established asset class. But that's the type of stuff we love, where we can get a mid-teens to low-twenties return. Not by taking a ton of risk, but by just finding something that no one's done before.

Patrick: [00:50:21] The part of this that would seem most difficult to me, maybe I'm wrong. But, is deal flow and sourcing of this stuff. So, what does that process look like?

Ali: [00:50:28] It's been probably our competitive advantage. So, we see about 200 deals a month, which is really overwhelming. That's, by the way, total vanity metric, right. Most of this stuff sucks. But every once in a while you see something that checks a lot of the boxes. And one of the processes we go through, by the way, is we never try to ask a company a question in person that we could have asked online or over email. So if you and I are talking, and I ask you who your competitors are. I've wasted both of our time. That's incredibly disrespectful, right, because I could have asked it over email. If I'm asking about market size all you're going to do is give me a big number and say I'll follow up with an Excel sheet later where I broke it out. By the time we're meeting you in person, all that stuff has to be figured out. That way we're using each other's time efficiently. And that way you can do really deep diligence on the companies that you're getting close with. And not just sort of the trivial stuff. And how we see deals, so we're seeing deals from seed. Having a venture capital business allows us to build networks in the venture capital community. And every single time one of our friends in the seed world says, "Hey, I found this cool lending deal. I can't do the equity without somebody else doing the debt because I don't want them to use equity capital to make these loans, or beyond a few $100,000 of these loans." We get the call and allows us to get in really, really early into these deals.

And we're built as a firm to figure out how to structure facilities with companies that don't have a lot of capital on their balance sheet. So, we funded a company that was lending against the title of some asset. And it was a start-up. We wanted to lend to them directly, and everyone else would have said, "You have to put that in an ABL facility. You have to take the title, put it into an SPE, lend against the SPE. It's bankruptcy-remote, et cetera, et cetera." The problem is, every single state has different rules. And the cost of transferring titles was high enough where it would have knocked off 500 basis points for the loan. There's no way you could have put that into an ABL facility. There's no way that could have fit within a box of the traditional lenders that you're thinking of, who are the master firms of today. This company needed a unique facility where we could make a loan, trap all the assets, make sure they weren't issuing dividends, make sure they weren't selling off assets, make sure all their subsidiary for cobar was in a loan, so you couldn't have the first lien on a subsidiary where we actually didn't have protected security interests. There are ways to do it, but you have to be structured as a firm that says, "Look, this is a new company. They don't have the ability to due diligence on the laws of every single state if they want to set up an SPE in every single state. They can't incur all that. So, we're going to find the right solution for them."

Patrick: [00:52:53] It seems that you're certainly the only person I've spoken with that's doing something like this that also lives in the venture capital world. How much do you think encroachment there will be from competitors? So you talked earlier about, you want to get into an asset class if you feel that each time you do a deal, you're widening your moat versus kind of new entrants. How do you think about new people coming in and starting to do this? As overall returns, if you read anyone that's smart's commentary, prospective returns are lower than the past. And maybe this is a way of getting high returns.

Ali: [00:53:25] A couple of different ways. So, in that business specifically, the way we build moats is, if you do a deal with us, to do a deal with an early-stage company with a completely new asset. You want a 20% return. If you've been our LP for three years, four years, five years and we've been doing it for a while and of a sudden, we can do 12, 13, 14, you'll do it. And so now we're competing with a different product than everyone else is competing because it's cheaper. So I actually have a structural advantage by having done it earlier. On the podcast we were saying, I would give my money to a first-round for a two X return. And random VC fund I would require five X. First round for having done that for a long time has just built a different product. They could actually invest at higher valuations than other seed firms and still survive because they have a more loyal LP base. That's a different product. They also have their brand. And so, I think it's probably going to be a combination of those two things, where, the longer we've been doing it, the more trust we build with our LP's, the more track record we've built, the more expertise we have in structure and a bunch of really weird different things that are sort of the right fit for those companies. And we can build a differentiated product because of it.

Patrick: [00:54:28] You mentioned two really interesting ideas at the beginning, which is this idea of acquiring Airbnb's accounts, or acquiring Instagram accounts. Sounds a little, almost tongue in cheek but it probably isn't. Talk about how you would approach something like that, which is radically a new idea. I'm sure something that no one's rolled those things out.

Ali: [00:54:46] Yeah, no, look, we love looking at stuff that is just sort of, okay this is a new thing, how do you buy it? Instagram's new, there's a lot of famous accounts. At the end of each day I have friends who have sent me sort of funny posts. And those are not really famous, influential accounts. And they're starting to make money. The famous Instagram handles will go out to some sponsor and say, "Hey, I've got all of these followers. You should really sponsor this." What if you rolled all of them up, and then built a sales team and helped them scale. I think there's a lot of service providers in that space that are helping, they're sort of consultants to these famous Instagram handles. And helping them monetize. I do think there's an opportunity to buy all those up at assets and then build a sales team around them. What if people bought up all the best podcasts? And said, "Look-

Patrick: [00:55:27] I was just thinking the same thing.

Ali: [00:55:28] ... "Patrick, you've built equity value in this podcast. Your readership, or viewership, or whatever you want to call it, is probably high net worth individuals. It's probably people who are looking for financial services." I bet you people would have a really hard time figuring out how to value it because they have no idea how much they could monetize it for. They probably would try to value it on some value per listener, some value per downloads. But no matter what they do, it's wrong. It's just whether or not they are wrong on the wrong side of that better side. I think Airbnb accounts could be really valuable. If you're the best Airbnb host in LA, you probably have a lot of reviews. Your pictures are probably great. You probably have a lot of people who've stayed there. That's a competitive advantage. There's some asset there. I don't know what that asset's worth, but there's a way to buy it. And I think that there's a lot of these digital assets that people haven't figured out to purchase yet that maybe one day we'll go after. I don't know, I think there's a million things. There's digital stuff. I think, by the way, one of my dreams if I'm ever done investing in only tech is, doing a tattoo parlor rollout. I don't know if you can name one brand in the tattoo space.

Patrick: [00:56:29] Nope.

Ali: [00:56:30] Right, but there's Claire's for earrings.

Patrick: [00:56:31] Yeah.

Ali: [00:56:31] Right, why isn't there Claire's for tattoos? Tattoos are going on this ridiculous kegger by the way. So, I'm totally bullish on the tattoo thing.

Patrick: [00:56:37] Can you say anything more about that? How did you come across that idea?

Ali: [00:56:42] I couldn't name you that. So I have a few tattoos. And I couldn't name you the first name of the guy who gave me two of them. That's crazy. These things are on my body forever. And I couldn't name you the guy's name. That's sad. I mean, maybe that's a reflection on me. But I bet you that if you asked most people with tattoos they'd say the same thing. There's no brand affinity. The best way to discover tattoo artists is on Instagram. You should really follow some of these guys, they are incredible. Maybe I'll buy their handles one day. I really do think there's an opportunity to take some sort of prestigious tattoo parlor and then roll out the brand to a bunch of others.

Patrick: [00:57:13] So, it's a good example, we'll roll out the Instagram one because it's a good way to see how you think. So, let's go through that process. So let's say you figure out the least wrong way of valuing an Instagram account, whether it's likes or whatever. And you want to go acquire some famous account. And you do so, and you agree on a valuation. The seller agrees on a valuation. How would you structure that to ensure continued alignment with the producer that's created the asset? Because obviously, in most cases, in that case, this is not somewhere you can hire a new manager. You need that person to continue.

Ali: [00:57:48] Maybe you need them to-

Patrick: [00:57:50] I guess that's if it's a person where they're in the picture a lot or something.

Ali: [00:57:53] Yeah, so I'm trying to figure out what I'm allowed to say on the podcast or not. So, the Airbnb world's really interesting, right. You have people who own the properties, you have the people who lease properties to then manage and rent out to other people. So, the people who own the accounts aren't often the people who own the real estate, which is sort of interesting. I think it's important to differentiate the two. And you might have people who have-

Patrick: [00:58:14] That's why I chose Instagram, not Airbnb, by the way.

Ali: [00:58:16] Oh, sorry. Okay. I'll finish Airbnb and then I'll go to Instagram.

Patrick: [00:58:22] Okay.

Ali: [00:58:22] So, the way I'd probably think about Airbnb is I'd say, "Okay, the account is probably more valuable than this person's incredible expertise on taking pictures." I think a lot of that stuff you could probably repeat yourself. I think you could make sure there was clean towels. And I think that the Airbnb ecosystem will end up being similar to the hotel ecosystem, where the management company and the property owner and brand. And I think you'll end up differentiating those. And I think there's a time, Patrick, where you're going to go to Airbnb and you're going to see a towel with a logo. And you're going to recognize that logo from another Airbnb. And like, "holy shit, there are service providers in this ecosystem."

Instagram, I think that's tricky because I do think that it's harder to repeat the magic of that Instagram handle. And I think it's probably less about buying majority ownership. It's probably like funding the GP of a fund, where you have some sort of compensation committee. And you say, "Look, you can't take all the revenues of the business." There's got to be some sort of governance. So I think you probably have minority economics, but majority governance. Is probably how I'd think about that. And by the way, I hate that people always marry economics and governance. And the way they don't, they say, "Oh, well we have protective provisions. That's our way of disentangling the two." I think that you could go beyond protective provisions when trying to disentangle them.

Patrick: [00:59:32] Can we talk about sales and marketing a little bit? You wrote something that piqued my interest about the importance of let's say seed-stage venture firm marketing itself and its partners, versus a later stage firm. That's what made me get onto the topic. I'm not just interested in that observation, but more generally speaking how you think about marketing your own firm, how important it is. Marketing and sales at the firms where you're an investor. I'm fascinated by this topic.

Ali: [00:59:57] So, the blog post I wrote was that seed-stage investing and series A investing are two different businesses. One's a B2B business and one's a B2C business. The reason C stage investment is a B2C business is you're basically going out and finding people who are going to start companies. And what that takes is brand awareness. You kind of need people to come to you, because it's hard to know about something that doesn't even exist yet. In some cases, you can figure it out by knowing a lot of people and having a lot of impressive friends who will one day start a company, et cetera. But it really is a marketing business. Series A investing's a B2B business because you're investing in a company that's already a company. So it's almost like a sales process. The hard part or the problem with that is, marketing is more expensive in many cases than sales.

Seed-stage investing and series A investing are two different businesses. One's a B2B business and one's a B2C business. The reason C stage investment is a B2C business is you're basically going out and finding people who are going to start companies and what that takes is brand awareness. Series A investing's a B2B business because you're investing in a company that's already a company.

So you have a seed fund with a smaller fun and less management fees, doing something more expensive than what a series A fund can do. And so, with our firm what we've done is, we've really tried to turn ourselves into a B to B business by saying, "We want our deal flow not to come because everyone knows the name CoVenture." We hope that happens one day, but until then, we want to just have great relationships with other seed-stage firms and solve their problem. Which is, a founder goes to a VC firm, says, "Hey, you should fund me." The VC firm used to say, "Go find a technical co-founder." And instead what we want them to say is, "You should go talk to CoVenture and launch the product, and then we can invest." For lending, we've done the same thing. It's the same sort of B to B model, where we say, "You want to invest in a lending company, we'll let you do that because we'll provide the debt financing for it and de-risk your equity investment."

The hardest part of starting a technology company used to be building the product, and now the hardest part of building a company was acquiring your first customers. And I think that that's part of sort of our investment model, why we focus on finding founders who are most equipped to go find those customers. I also think the fact that technology's made it easier to build businesses. I'm going to say something sort of unoriginal, because other people have said it. But I do think it's true, which is, it's less and less expensive now to start a company. But more and more expensive to scale a company, right. So we're invested in a few consumer companies. No matter what consumer company we're invested in, there will be competitors. There will be other people who are trying to do it. When the technology was hard, you actually might have been the only person in your space.

The hardest part of starting a technology company used to be building the product, and now the hardest part of building a company was acquiring your first customers.

And so, getting the application up and running was expensive. But then once you had it, you could kind of scale quickly because there were no other markets. You could buy ads on Google really inexpensively, et cetera. So I do think that you kind of have to find really interesting distribution channels now. And you probably have to invest a lot of money. A lot of founders come to us and they say, "This is the last round I'm ever going to raise because then I'm going to be profitable." And we tell them, "That's not true. You're going to have to raise capital to create defensibility. You're going to have to go get markets before anyone else is there and create a presence where it would be uneconomical to even compete with you. Because you're already at scale, and it takes away the value of building a business."

One sort of thing I'll add to that because I think it relates to how people think about raise, and fall, and rounds of capital. I think when it comes to acquiring customers, it's just way more expensive now than it used to be. I think that raising capital can do two things. It can make your company less risky by having more runway and buying all those customers. It can also make it is more risky. VC's love to say, "Oh, you shouldn't raise too much capital because it makes you spend more money and you have to grow faster." And all these different things. And I think there are a lot of things that are in the best interest of VC's to say that. We have a portfolio company that is thinking about raising a large series B right now. And we told them, "Look, you've raised, let's call it 10 million dollars to date. If you raise 25 million dollars in this series B, if you don't sell your company for 35 million dollars or above you will make zero dollars because you're going to have preferred equity on top of you. If you raise a seven million dollar round, if you sell that business for 35 million dollars, you still made 10 million dollars. You're actually still a wealthy individual." So, putting that much preferred equity on top of you, I think is really scary. I think people spend a lot of time optimizing for valuation and don't think as much about structure. Preferred equity's kind of like debt and I think that people probably don't think that much about it.

Patrick: [01:04:00] You mentioned tattoos parlors, and I would love if to hear any other interesting longer-term aspirations that you have. While you think about that one, I also like to think about it negatively. So, if there are industries or types of businesses that structurally you just find uninteresting and likely would never play.

Ali: [01:04:19] I'll start with things I like because I'm an optimist. You had another guy on the podcast who was talking about bail bonds. I think bail bonds are still a place that should probably be cleaned up. The way a bail bond works is, average bail's about 25 grand. So let's say your kid goes, gets arrested. Most people don't have $25,000 on them, so they'll go to a bail bondsman. And he or she will say, "Great, give me 10% of the money. I'll put up the bail for you and as long as your kid shows up to court, I'll get my money back. And by the way, if your kid doesn't show up to court I'm going to send a bounty hunter to go get them. And I might also put a lien on your home." So it's a 300% APR product that's secured and by the way, there's no discriminatory law. That's bad and good. It's bad because you could be racist and do all these horrible things that there are reasons you can't profile when you're making loans. But for whatever reason, bail bonds aren't like that.

The reason it's good is, you don't have to do hard crimes. If you ever built a bail bond business you could say, "Look, I'm not going to do anyone who did any hard crimes, anything that I'm morally against." I think that A, it's a social justice. I think the bail bond systems totally messed up. If someone can't afford bail they're in jail for 30 days, they lose their job, they lose their apartment. Their life is ruined. I think there's a way to create a fairer product in that space. I could probably tick off a number of things that I think are interesting. I'm just trying to figure out what's reasonable and won't get me yelled at the office. Because they get more and more bizarre the longer I go-

Patrick: [01:05:36] Do the unreasonable ones. I'll give you a free pass from the office.

Ali: [01:05:41] Let me go do ones that I disagree with a little bit. I think a lot of the worst ideas that we see are not bad ideas because they're bad ideas, but bad ideas because everyone thinks they're just overpriced. Everyone says, "Hey, are you going to invest in Blockchain companies?" I've heard a lot of people talk crap about Bitcoin, but I haven't heard a lot of people talk crap about the Blockchain. I think every bank executive has been explained to them by their PR firm that they're supposed to say they like the Blockchain, even if they don't like Bitcoin. So it's really hard to find a reasonably priced business in this space. I think insurance companies and lending companies are built similarly. So if you think about insurance companies often start as customer acquisition businesses. Then they get better at underwriting, then they become the carrier. Lending companies are the same, right. Most of the first wave of lending companies were customer acquisition businesses. "Hey, let's just do this online instead of in a bank." Then they got better at underwriting, eventually, they'll actually figure out a unique way to access capital, which is bad for my business. But insurance companies are just so expensive to build that it just doesn't make sense for the venture capital model. And so I think that people were like, "Awe, man. Insurance tech is cool. Warren Buffet likes insurance and other people in financing like Warren Buffet. So I kind of am a techie, but now I can talk about insurance."

Patrick: [01:06:46] They like flow financing.

Ali: [01:06:47] Yeah, yeah-

Patrick: [01:06:48] I don't blame them.

Ali: [01:06:48] ... They heard the word flow financing and they were like, "Wow, I finally get finance."

Patrick: [01:06:52] Cool.

Ali: [01:06:52] Finance, sorry. And I don't know, if you look at like, Metromile's an amazing idea. Metromile basically says, "We're going to underwrite your auto-insurance based on how much you drive." Genius.

Patrick: [01:07:05] Great idea, yeah.

Ali: [01:07:06] I still wouldn't want to be in the seed round, because I'd probably own 0.0001% of that company now because they've raised so much. I just don't think insurance really makes sense for the venture space. I think it's more like just trend lines. By the way, you see a big round, Sequoia does a big round of a company. And then every seed fund is like, "All right, I'm going to find the next one that Andreessen Horowitz can do." So, those are sort of the themes that we try to stay away from.

Patrick: [01:07:28] Back to the unreasonable ones.

Ali: [01:07:30] Employers lending to their employees. So there's a large company that I kind of got to know. And they have a bunch of truck drivers. And the truck drivers can't afford to buy trucks, so they lend to the truck drivers and then give them the work. So they're lending and then making sure the loan gets paid back by then giving their own employees work. I think employers are really good at underwriting their own employees. I can't believe that some of these really, really well-established businesses, as soon as they hire someone out of college they say, "By the way, I'm going to lend you money to get your apartment." I don't know, I'm surprised there are not financial products offered to the employees of larger companies.

Patrick: [01:08:05] Just a couple of closing questions. The first one is your view on the potential negative impact of free content. You wrote kind of an interesting write up about why the seam scrape might actually be driving a really horrible trend. Could so summarize that line of thinking.

Ali: [01:08:26] By the way, this was more interesting when I first published it than now because I think that this was before the term fake news. But I think that people look at visual media and Twitter as these great tools to democratize the minority voice. And it said, "Okay, this is really great. All of a sudden people who are often not heard because of agenda-setting, or because CNN doesn't want to publish it, could never get their view told." Now we have John Oliver but at the time. But the reality is, free media is completely misaligned with its readers. Because the readers are not the customer, the customer is the advertisers who are publishing ads on those posts. And so, really if you're a media company whose model is to get free viewers. That viewership is your product. And the way you make that product is, you write articles that you know that product is going to be attracted to. So writing the articles almost becomes your marketing tool. It's just a marketing engine. It's why we have listicles, it's why we have crazy headlines, it's why we have these sensationalist things because all you're trying to do is say, "I need to find women between the age of 20 and 28 who like X, Y and Z product. And I'm going to write posts about that product to aggregate them so that I can then go to Sephora and say I'm going to market to them." Or, "I'm going to find men between the ages of 45 and 60 who like bowling, or whatever. And I'm going to write just a bunch of posts about bowling. And I don't care if they're true or not, I just need to aggregate that audience and then go sell ads to advertisers."

However, paid media is completely aligned. All of a sudden your customer's your reader. When I read the Financial Times, I'm paying a stupid amount to read something that's actually meant for me. So the odds that it's actually correct, the odds that it's high quality are incredibly, incredibly important. So what ends up happening is the people who are poor continue to listen, watch or read free media not meant for them and productizing them. Whereas the people who are wealthy are going to continue to get correct information because they're paying for content that was actually meant for them.

Free media is completely misaligned with its readers. Because the readers are not the customer, the customer is the advertisers who are publishing ads on those posts...paid media is completely aligned. All of a sudden your customer's your reader.

Patrick: [01:10:19] That gap might widen, get worse.

Ali: [01:10:21] Yeah, and I think that's really sad. We wonder why people are getting false information, it's because the information was never meant for them. And we're frustrated by it, we should be. I don't know how to solve it, but I think paid media's really important. I think it's really important that we pay for content. One of the things I get excited about though within media, and in stuff that we do pay for, I love the idea of Netflix and HBO. And I think that what Netflix and HBO will do, are do what books did for Shakespeare. So, I grew up going to school reading Shakespeare and thinking, "Wow, this is the worst stuff ever." And I know that I'm supposed to like Shakespeare because I think you're sophisticated if you say that you like it because it's classic. But really it's these sonnets, and there's a certain amount of syllables on each line. I think it's 10. And you have to figure out how to tell a story within that structure.

And then eventually someone said, "Well, it'd better if you just sort of loosened up the structure and you wrote books." And books became more and more flexible. And all of a sudden, you had 500-page books, and 200-page books, and sentences that started with the word and. And you had paragraphs that were different lengths and chapters that were different lengths. I think the two-hour movie is the sonnet. And I think my kids will probably never watch a two-hour movie, except in their classroom as, "This is how people used to watch film." And the reason is, Harry Potter should have been an HBO series. And every book should have been its own season and every Horcrux its own episode. We got gypped by the fact that they were two-hour movies. Big Little Lies, I thought was a cool show. Yeah, I thought it was fine. But that's movie star-level talent on a TV show.

And that story was told in the right amount of time. I think this thing that HBO and Netflix still get wrong is, every single show is told in the same amount of time. Every chapter isn't 10 pages. So why is every episode always 40 minutes, or 60 minutes, or 30 minutes? Every sub-plot should be told in its own amount of time. I think we're going to get there. But that's proof that the reason structure built the stories was because the ads. Because cable had to fit, you were not the audience. The content wasn't made for you. It was content just good enough to get you to watch it so they could serve you ads. Netflix you're paying for it, theoretically. Or your friends, friends, friend is paying for it. So it was actually meant for you.

Patrick: [01:12:21] Before I ask the closing question that I always ask, I just want to say thank you. I will really remember this conversation probably more than most, to be honest, because you have this incredibly unique way of looking at things as they should be, or could be, versus how they are. And approaching things with a very open mindset. I'm blown away by it, honestly. I'm really impressed, and I appreciate all this time. The last question you know is coming because I ask everybody, which is what the kindest thing that anyone's done for you is.

Ali: [01:12:51] My first job didn't work out. And so, my second job was working at a company called Chloe's Soft Serve Fruit Company. And Chloe's Soft Serve Fruit Company sells soft serve fruit. So, it is not frozen yogurt. It's actually made of only three ingredients, fruit, water, and a touch of organic cane sugar. And there are only 80 calories in a small. 16 grams of sugar, there's no dairy, no allergens. It's a kosher pareve. And I know all this because my second job was passing out flyers on the corner of 17th and Broadway. You want to meet the meanest people in the world, it's the people who are in that area trying to ignore a person passing a flyer into their hand. But the guy who owned the business turned out to be a guy named Michael Sloan. And Michael was the CFO of a private equity firm. He was secret shopping and I made a web analytics joke to him. He goes, "How do you know about web analytics?"

I'm like, "Well it's sort of interesting. I used to be the president of this tech start-up and now I'm not. Now I work for you for probably two dollars less an hour than I should be making. But if you want to raise my current pay that'd be great." And we start talking. He's like, "I went to Cornell as well. You should come to my office." So I went up to his office in Midtown, and this office was bigger than my parent's apartment. I was floored. I had never seen a marble floor. This was cool. And I was wearing my best khakis. And he goes, "Look, I think this is cool that you came to work for me. It's cool that you tried to do a start-up. And I started a company as well. You should go to school and keep taking risks. And no matter what, you can always work for me."

And that was when I got to be able to continue to take risks, I didn't have to go down the traditional banking path. I didn't have to go down the traditional consulting path, or one of these sort of paths because this was a guy who said, "Look, you worked your ass off passing out flyers." By the way, I was really good at passing out flyers. I had lines coming in, it was awesome. I'd do and say anything to get people in. He said, "You worked really hard. I think that I've always wanted to help somebody at your place in life. So you can always work for me, keep taking risks." And then he ended up becoming my first investor in CoVenture. I still love Chloe's Soft Serve Fruit Company. It's still in our freezer every single day. And if you haven't had a Popsicle you can get them at Whole Foods or all these different places. And he's the CEO that I most admire, and he does the nicest thing anyone's ever done for me.

Patrick: [01:14:56] What was your best tactic for getting people to take a flyer?

Ali: [01:15:00] So, people would walk by and I'd say to people, "Do you like yoga?" And they'd say, "Yeah, I love yoga." I was like, "I love yoga too. You know what? People who love yoga love Chloe's Soft Serve Fruit Company." And that was probably the number one.

Patrick: [01:15:15] Commitment bias, I love it.

Ali: [01:15:17] I can't say the others.

Patrick: [01:15:18] Well this has been a blast, thank you so much for doing it. I hope that given that I think you're in New York pretty often, that we can do this with some regularity. This was a blast.

Ali: [01:15:26] Thank you very much, I really appreciate you having me on the show.

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