E132 INFORMATION RIGHTS: The Clause That Saves Founders | Arthur Bavelas + Andrew Romans

Speaker A: What I came up with, which I mentioned in one of my books, which I thought was counterintuitive but can be life changing financially, is for the founder to negotiate information rights. So you know, you've got Arthur investing in the startup and you're getting information rights and you know, you realize that's not dumb. But the founder thinks I am the source of information. Why would I need to codify legally that I have information rights and access to the financials and an update of the company and it can inspect the books because one day you as the founder might have decided to move on or you might have been, you know, Steve Jobs. You know people talk about Apple in between Jobs like you know, he, he was kicked out, did next, probably had no information rights and if he wanted to sell shares in Apple and people didn't know have access to the because it was privately held, if it were, uh, that would have been life saving for him to sell some of his Apple stock and fund next.

Speaker B: Welcome everybody to another episode of Arthur's Roundtable. Super grateful to the Family Office Insights community for viewing and sharing and socializing this with people that you know. Uh, we really experience uh, an increase in people actually watching these and listening to these and so I hope you enjoy them and thank you. We're super grateful. Uh, and Andrew and I known each other for I don't know, a couple years now, maybe even longer, sat down for a cocktail in Austin maybe a year and a half ago and uh, really skilled VC and good uh, guy. So I'm really grateful. Andrew, thanks for joining us today.

Speaker A: Arthur, thanks for having me. It's great to be back here.

Speaker B: Yeah. And so we did an episode before. Really looking uh, forward to catching up. But I have to share something with everybody that I learned from you, which is many people might know but I didn't know at the time. One of the things that you uh, in our many conversations that we talked about is that when you invest in a company, don't forget to put into the documents that you need the right to information post whatever happens, whether it's them, um, crashing and burning, succeeding, they giving your money back if it was a note and putting into the documents that you have the right to get the information so you can reconcile whatever is happening next with your investment. Which was really good advice.

Speaker A: Yeah, I mean the, the information rights typically are granted to the VC in these, in these, you know, legal docs, you know, all kinds of rights and privileges and information rights is one what, what I came up with, which I mentioned in one of my books, which I thought was counterintuitive but can be life changing financially, is for the founder to negotiate information rights. So, you know, you've got Arthur investing in the startup and you're getting information rights and you know, you realize that's not dumb. But the founder thinks I am the source of information. Why would I need to codify legally that I have information rights and access to the financials and an update of the company and it can inspect the books because one day you as the founder might have decided to move on or you might have been, you know, Steve Jobs. You know, people talk about Apple in between Jobs like, you know, he, he was kicked out, did next, probably had no information rights. And if he wanted to sell shares in Apple and people didn't know, have access to the because it was privately held, if it were right, that would have been lifesaving for him to sell some of his Apple stock and fund Next because. So that's the thing. It's counterintuitive to think I need to negotiate information rights when I'm the damn founder.

Speaker B: Yeah, totally makes sense. Super smart. Anyway, I wanted to just mention that because it's one of the tidbits and of course I've read your book, is super grateful for it, um, and uh, enjoyed joy learning from it. But let's talk about what's going on with uh, uh, vc, AI, how that all integrates. You've done a bunch of trips, uh, over the past year, socializing what you're doing and bringing some of the companies that you've invested into those events. Let's, uh, update everybody about that.

Speaker A: Yeah, I think people are probably getting fatigued about hearing about AI. But you know, I was saying to you offline right before we started recording this that one of the things I have to tell everybody around me, including myself, is stop what you're doing and can I be doing this on Cloud or OpenAI or whatever AI that we have running inside of this company or in my life. So, you know, you just keep forgetting like somebody asked me to make a graph visualizing what kind of returns and how long it takes or something. And I was like, dude, you take all this, upload it yourself and stop telling people to do something like that. You should be using AI and make a cage match of anthropics, Claude fighting, you know, Sam's OpenAI ChatGPT and see which one, you know, you're happier with. Um, but I would say since the last time we spoke, I decided, all right, I think I'd be Stupid to not put some of our venture fund uh, for money into OpenAI XAI, you know, and anthropic. And now XAI is merging with uh, SpaceX. And normally my perspective is we're the early VC guys and when we get the, when an exit happens, you know, when the company gets sold or IPOs, there's usually a uh, piece of paper that I always request if they don't give it out, I said I want to see what multiple the precede investor made. Pre seed two, precede four, whatever it is, you know, series A, series B, series C, series D. And I love seeing it. And what's always clear is that now it doesn't show how much money the precede guy lost on the companies that went to zero but it says like hey man, the guy, you know, we made a 58x on uh, that so 50. So a million dollars in 58 million dollar back. Woohoo, that's great. Yeah, uh, the guy ahead of us made like 158x. Wow, good for him. And he just wishes he written a bigger check but he's probably got 200 others that went to zero that's dragging that down. And then you see like the final guys that you think of as the biggest name in VC, they made like 1.02x. And if you figure in that they had a 2% management fee times 10 years, they lost money. Yeah, they lost money on that. Now they wrote a check for 150 million at some crazy decacorn valuation, um, and they're getting management fee on that and they're not short of cash, they're making a lot of money but they lost money for their fund on that. And so I've always kind of been like the delta between entry point and exit point should be big enough that we're able to really outperform the market. And there should be a premium for being somewhat illiquid in a venture capital fund. And so if I'm just delivering 1.2x as a monster fund, I'm losing money to inflation. So people are always saying to me, Andrew, I've got some SpaceX, some anthropic, some OpenAI. Do you want to buy some of that personally or from your fund? And I've stayed away from it. And then all of a sudden I said if I've got direct access to buy some SpaceX, some OpenAI, some Anthropic, some replit and some of these mega names that maybe not everyone's heard of, I think my LPs would not hate me if I managed to get them into a spread of all four or five of those. If I've got access to Anduril. We've been the seed investors and guys that were the first employees of Anduril. If we're, like, the only guys with access to that, maybe I should get a little bit of my fund money into that. And so we started talking more and more to VCs, uh, about discreetly selling us some of this without any negative signals and structuring it so that we don't get Rowford and there's no transfer permission getting blocked on, you know, transferring

Speaker B: this talk that would. You know, Palmer Lucky is just lucky. He's smart. It's just unbelievable what he's done. He's moving so fast, right?

Speaker A: Yeah. Yeah. I mean, he's taken everything from his past experience and rolling it all into it. I mean, I remember in the beginning of my career, uh, you know, saying, are people willing to work in military, you know, you know, applications? My very first job out of undergrad was I was a UNIX headhunter. And so we had, like, all these keywords, and one is, yes, you know, thumbs up, thumbs down, and doing anything that's got a military application to it. And it must have been, like, 4% of software engineers were willing to do it, really. And that's just the engineers, you know. And if you talk to the VCs, the VCs typically said, Do I want to, um, give myself a financial incentive for the world to go to war and for our country to go to war? And people kind of said, like, I just don't want to wake up, wake up in the morning and be like, you know, you know, Hallie Burton, you know, you know, Dick Cheney being like, let's go to war. Because I. I get. I got a clean 2 million for Tomahawk.

Speaker B: Yeah, right.

Speaker A: But on the other hand, you think I've paid a lot of money in taxes. I don't dodge any taxes.

Speaker B: I pay all my taxes that you're financing the department.

Speaker A: Do I want. Do I want our aircraft carrier to all get sunk by a bunch of Chinese subs in the first three minutes of an outbreak? And it looks like Pearl harbor, everything's in the bottom of the ocean. Or Darwan Palmer, Lucky to have completely reinvented underwater warfare, and he's got all these baby drones and these baby subs, and they're all flying around, and they can flick a switch if we're losing and put it on auto, you know, AI kill mode. I mean, it's Un. Um, I'm actually less worried about our aircraft carriers all getting sunk in the first five minutes.

Speaker B: I think it's fundamentally the defense of the nation. Like, we want to be safe. And the other thing that Palmer does, he just started a de novo bank. You know, we're big fans of Mercury, which you're probably aware of.

Speaker A: Sure, of course. Yeah.

Speaker B: And, uh, I mean, they're, they're just killing it. And so the, the marketplace is ripe for sucking up the vacuum from Silicon Valley Bank. Right.

Speaker A: Yeah, yeah, no, no, I think it's true. Uh, the, the. I mean, everybody had SVB was 55% market share, and then it was SVB guys that shot off, that did First Republic, and then the guys who were at square one in signature, and all those guys, everyone can be traced back to having had the white gloves where you get a limo in front of your house on your wife's birthday as your bank. And then, and then when the run of the bank happened and we're all kind of like, had to put money in big four banks for a short period of time, even like chase. Yeah, the J.P. morgan guys are. I mean, I don't want to say anything bad about anybody, but it was a very shocking experience to go from the SVB or, or excess svb, uh, guys to anything else. But all that stuff should change. I mean, like, I can't believe. I mean, VC is about timing, and I'm sure wrong about a lot of timing. I've been saying for, like, a very long time that I can't believe Visa, MasterCard and Amex are taking a tax on so much of, um, all the purchases that are going on. And it is so solvable, even the idea that the merchant has to wait to see the money clear into their account.

Speaker B: Yeah, it's crazy.

Speaker A: Should all be instantaneously crypto. So I'm wrong, repeatedly, but I can't believe that didn't happen the week after Bitcoin came out.

Speaker B: I don't know that much about it, but Ripple's been trying to solve the Swift problem and they've got the, the, the whole international, uh, uh, we actually don't suffer in the US like other countries suffer about transferring money. So the pain points aren't that big with us. All right. So they clip a few cents. At least we know the money's going to get there. Right. And that's why crypto has become so popular in other parts of the world, is because they can trade outside of the system and it's, you know, more or less Instant, instant. But we'll see what happens.

Speaker A: Yeah, it's always been the case. I mean somebody who's got like their money, Americans that are all dollarized, huh. Just don't care. Whereas if you've lived through hyperinflation in Argentina three times and you're, you're under 50, you're like, hey man, this makes a lot of sense to me.

Speaker B: A lot of sense.

Speaker A: These stable coins are changing my life. And you know, and then people that move money around, so international people also like West Coast VCs didn't really understand the economy in my opinion. Like Greg Kidd, you mentioned Ripple. Greg Kidd tried getting me into Ripple to invest in it when he just joined his employee number 13. And that's one of my great regrets obviously that I didn't do that. But he was working at like the Fed, you know, he understands like the economy better than your average Sandhill Road vc. But I would say where we normally stay away from that late stage type stuff. We're at a moment in history that we're so excited about the growth potential of. SpaceX merged with Xai with Anthropic, with um, OpenAI with Anduro with Replit. And all these life changing, we're investing in all of them now.

Speaker B: That's so great. Do you see uh, ah, Open Claw staying because it's open source. Like how do you monetize that besides using it? You probably can't.

Speaker A: Well I think that that's kind of part of um, accelerating the lowering of costs and dealing with, you know, walled gardens of information. I have an uncle who um, he's in his 70s and he's still practicing law, um, quite healthy. And he was saying uh, we're not as a policy using AI because we don't want to give them all of our docs. And I was like, you know, I call him uncle, not son. But it was like, hey son, I uh, think that the cat's out of the bag if you try, if you just say what you want, like as dumb as the way your client would ask for it, it's going to give you something much better than you're even giving your client. You know. So in some of those it's like

Speaker B: at least it gives you a 90% start on something that then can be crafted, you know, idiosyncratic to the issue that you're trying to solve document wise.

Speaker A: But yeah, yeah, there's still some strange mistakes I'm spending a lot of. It's still kind of bizarre like you say, like, all right, I've added section 14. Do I have to tell you that section other existing 14 is now 15 and so on and so on and it does it. Then you're like, why is the formatting so bad? Yeah, I'm like, maybe we should hire that associate back to do this for me.

Speaker B: Yeah, I uh, Listen, you still need the, the value I think going forward is the person who can prompt properly and then edit properly. Right. And let's happen through the uh. Because the LLM is basically the next best thing, right? It's like autocorrect, right? It's doing a bunch of the next best thing. And so at some point and it's been, the hallucinating is getting better I think, don't you?

Speaker A: Well, yeah, I'm almost shocked, I'm almost shocked that um, I'm seeing the mistakes that I'm seeing when everything else is just so mind blowing. Right. But uh, I, I think that it's exciting to think of it getting just cheaper and cheaper and cheaper and better and faster. One thing that's interesting is that um, we're doing an SPV and I can't say who they are, but the revenues went from 2.8 million in the beginning of 2024 to 275 million by the end of last year.

Speaker B: Crazy.

Speaker A: And then between January 1st at uh, 2,75 million, you know, run rate annual, it went from December 31st to yesterday, March 4th, um, it went to 4, uh, hundred million, you know, and, and, and other people were like, yeah, but what's to stop anthropic@OpenAI with their funding and resources from, you know, destroying that company and cannibalizing it. And you know, you could think if they wanted to point all their cannons at this company, they could blow it out of the water and sink it to the bottom of the ocean. And, and, and it occurred to me that um, when, when we started investing in startups that were running on the closed source, open AIs and anthropics of the world, um, we were worried like, what if they raised the price on you?

Speaker B: Right?

Speaker A: You know, like, like you are, you know, like your motor runs on gasoline and you're only getting it from them. What if they cut you off? And they, they started saying, well, we've already successfully moved across these multiple different paid for LLMs and we didn't have any interruption whatsoever to our product. It's like, are you a rapper on top of that? And so there was a period when we were scratching our heads of saying, should I be funding this company? Because the Rug could be pulled out. Like, you know, I know a guy who, his business completely rocketed on top of Facebook. And then Zuck just pulled the rug out, unplugged him. He was backed up by, like, Sequoia, and his company went to zero. It's like, you don't want that to happen to you. But then they started saying, well, actually, we built our whole thing on open source, and so there's no rug that could ever get pulled out. And if we wanted to, we could float between them. But so then we started saying, okay, I'm ready to take a chance and a risk and we're diversified. So if it, if I turn out to be wrong, I'm diversified anyway. And what did we see? We saw faster, uh, revenue growth than we've ever seen. Like, hockey stick promise that never happens was happening. Like the revenue growth we're just talking about, you know. And then, and then I realized on the late stage, SPVs where people are like, yeah, but I'm worried that anthropic could just go after this. That it reminded me of, uh, when, like, people were saying, why should I invest in Cisco, who only has 8,500 engineers in California, when Bell Laboratories has 96,000 engineers in New Jersey? And they're just like, you know, why. Why would a smaller team in California be able to beat, uh, how could David beat Goliath? And it's just sort of like the VC and the founder. We've been off in our corner for so long that I forget that the rest of the civilians have this mindset of like, why would you ever put money into Cisco when clearly AT and T. Bell Labs has the advantage here. That there's that many, you know, Persians against that many Greeks is a suicide mission.

Speaker B: Is it? Because they. It's too small of a problem.

Speaker A: I mean, I think what founders and ent. What founders and entrepreneurs have learned in the technology space over like 50, 60 years is that a small team of highly mot. Motivated, dedicated people with some crazy leader like Steve Jobs can get more done than IBM or, you know, Big Blue and all the big guys. And then the big guys take their clip on, tie off at 4:59pm um, and go home where these guys are all together on Market street on Saturday and Sunday. Right? And it just. And, you know, a medical device could be made with a small team and a little bit of funding and then reinvent an industry and then have two copycats and then Johnson and Johnson and, you know, st chewed they go buy them, uh, for billions to then Become player number three in a sleepy market. So sort of interesting to see it at, at the level that we're at, that everyone's afraid of backing anyone that was on top of it. The LLMs and the agentic stuff. And then it got to open source and then now people are even afraid of Can Sam Altman eat the world with 110 billion financing and no profit for five years?

Speaker B: Yeah, it's crazy. What do you make of. Let's talk about the VC business for a second because I also want to touch on what Dorsey did and see where you think about that. But uh, traditionally, and I'm going to get the numbers wrong, but it's like the VCs invest early, flush 90% or more, the balance funds the whole project and everybody's happy. Is that formula changed.

Speaker A: Say that again.

Speaker B: So you invest in 100 companies, flush 90, 90 of them. The last 10% of uh, builds, builds the ROI for the fund.

Speaker A: I mean, so what people tend to say is that 90% of the returns come from 10% of your investments, right?

Speaker B: Yes.

Speaker A: Well, okay, the, the if it depends on the sector. You know, if you forget drug discovery like biotech, and you forget medtech where there's clinical trials and FDA kind of, but where you have to jump up and down on a landmine multiple times of total risk of binary failure. If you look at investing in general software tech, AI companies, um, if you're investing in pre revenue companies, you're getting in at a much lower valuation. And so your little check is buying a much bigger percentage of the company and theoretically the total failure rate is much higher. So like Ron Conway, SV angel, the original Dave McClure at 500 Startups, they might have like a 70% logo death rate, but they maybe invest like an entry point, like a $1 million check into 25 companies and then like two thirds go to zero. And then they put in $5 million checks into the surviving winners and then they put like 10 or 15% of the fund into their top three. And so the percentage of logo, the percentage of logos that fail might be 2/3. The percentage of capital that went to zero might be one third. M. But it depends what your strategy is. So some guys are like, I just write a check. Like Ron Conway would historically say, I write a check for 150k and I never follow on, never. If I did, it would just be too much of a negative signal and a mess. That's what I do. Now he secretly did a hundred million SPV and LED and priced a, uh, 200 million round into Pinterest. So I mean, you know, he managed to go after that winner and he did the same thing basically with Twitter when that was the biggest growth thing in history. But I think that if you think of yourself, of living the life of a VC and you have a high failure rate perhaps of 1/3 death rate of your logos or 2/3 death rate of your logos and then finally you have an exit and that pays back the whole fund. So one exit paid back the whole fund. Then another one, you might be in it for $20 million and it sells for 50% of the cash that it raised. So you put 20 million into it, it's raised 100 million and it gets sold for 50 million. You know, theoretically, if there's no carve out for the founders, 100% of the exit consideration went to pay back the liquidation preference 1x and you got 50 cents on the dollar. If I'm already in carry.

Speaker B: Yeah.

Speaker A: And I get $10 million back. My uh, LPs may have already made 6x. Okay. They might it for every million bucks they put in. We've already wired them 6 million. The fact that I'm getting 10 million back on a uh, Wednesday.

Speaker B: Mhm.

Speaker A: I'm 50%, 50 cents in the dollar. Getting my money back doesn't sound like a great outcome. That's worth telling my wife. I'm like hey honey, yeah right. You just, we're, I'm m getting 20% of that 10 million and I'm not the only guy at my firm. There's a bunch of people that carve that up. But still you're in carry, you're going to get 20% of anything as the VC and, and you're saying to the LPs hey, you better re up in my next fund because you've made 6x. And it's still. This is the gift that keeps giving.

Speaker B: Yeah. Yeah. So those lingering checks after you've paid off the fund are you basically house money?

Speaker A: It's very important actually. I mean like uh, you know, it's, it's a, it's a, it's a great thing to be in a business where it's possible that a real ship can come in and you can make uh, you know, I was talking yesterday to a guy who invested in anthropic@uh5 billion with a good size check and you know their post money is 380 billion and there's not a lot of people willing to sell it. So I mean he's in a great position with that so it's wonderful to make these 100x's and, and all that, but making a 3.8x on a bunch of hard work companies that you spend more time on working with them than just stay out of the way of the one that's, you know, just really crushing it, you know that those are important. I think, I think it's important for everybody that you really focus on time and making careful decisions on getting something to a 3.8x and even a 2.5x. It's real money, it's their lives. You know, we have a suicide rate of people that actually commit suicide. So I think all of this is incredibly, you know, to be treated with great gravity.

Speaker B: Uh, is there something that the audience should know about besides you, which you know is important, like the person calling the shots with your partners. That's different about your fund 7 BC?

Speaker A: Yeah, I think, um, you know, I think if you're an emerging manager and you're trying to raise LP capital, that's the money that you then invest in the startups. Um, unless your fund is already getting to $100 million, there's almost no institutional money that wants to talk to you. So you're raising money from like single family offices, some rich entrepreneur, you know, your old boss, your old sales engineer that used to work for you, you know, you're raising money from just like one at a time and it's hard to scale. And the irony is that it's those smaller sub 250 million funds that are investing so at such a lower valuation compared to the exits that we get these days, that those losses mean nothing compared to what they make on a couple of hits where they really were up there. Remember like the, the spreadsheet in the end that says the last guy in who's the most famous VC you heard of, lost money on that, but he's not going hungry this Christmas. I mean, trust me. He made a management fee on this like 150 million check. He took 20% of that as a lock in, you know. But I would say that, um, what's different with us is that we've launched a fund of funds to say we want to invest in your sub $250 million fund that's completely ignored and orphaned by the institutional world. And so we invest in lots of little smaller VC funds and because they need us so much, we only invest in their final close. So we call this final close arbitrage. So imagine you've been out there meeting every little family office and friend and high net Worth from Park City to Orange county, and you've managed to get to 40 million and you're exhausted. And in fact, you said like, final deadline is September 30th, but who are you to push Mr. Big or Mrs. Big? So you extend it to December 31st, and then you're like, damn it, this guy can't meet me till January. And you extend it. And so you thought you would only be raising for 18 months. These guys are often raising for 36 months. And then, and then by month 36, they're like, hey, everyone's ready to re up in Fund 3. I've got to stop taking money on March 31, and I mean it this time. And I'm already closing 20 million on April 1st for the next fund. So what we do is we come in in the final close when they've already made like, 15, 25 investments. And some of them might have gone down, some are flat, but some of them are working and have raised much money at much higher valuations. So they might have funded a company at 10 million and then it raised at 300 and again at 600. And it looks like the next round is going to be 1.2 billion. We come in and say, you raised 40 million. Here's 10 million. It's the biggest check you've ever got. You can't say no to it. And we get in at cost. So that first investor with 250k or 1 million was $1 one unit. On the day that we put in the 5 million, it's worth 10 million by fair market value, the number of shares times the share price. We're, uh, up. So we call this final close arbitrage. And by going through every company that they funded, we know exactly what we're getting into. I don't care where you got your mba, I don't care how many times you've been divorced. I'm buying into a portfolio that's already up, um, 2x. And I can tell you if these are fundable to raise the next round.

Speaker B: So it's not that your, your terms are different, is your visibility is better.

Speaker A: Well, almost nobody is willing to write a $10 million check into a sub 2. 50 million, 150, 100 million fund where we've, we know mathematically, and there's no debating the data, is that, you know, funds that are for the last 30 years, according to the Kaufman foundation, that doesn't lie. Any fund above 400 million has a 10% chance of ever returning 2x. That means 90% don't get to that, our funds are steady 7x, you know, over almost 20 years. And we know these little funds, some are not going to do great. But if we see us getting in at 2x at entry point, you know, the financial statement for my LPs show we bought this at, you know, $5 million. Five, you know, million units. And an audited financial statement says it's worth 10 million and hopefully it gets to 3x5x from here or better. But what's key about this for me is being able to say, I went through your portfolio and honestly, there's only one that I'm really passionate about. I'm not going to invest in your fund, but either introduce me or I'm going to cold call that CEO and I'm going to pound my way in the front door or the back door and get money into that company. So we're cherry picking the very best deals out of the portfolios of early stage VCs before the big boys see them. And after we fund the guys that we do fund, we say, hey, what is your. How much of your fund have you exited and wired back to your LPs, thinking, well, Andrew, it's only been 24, 36 months. That's not enough time for good M and A or even any ipo. I'm like, all right, well, if, if we can return the whole fund 1x, it'll be a walk in the park for you to raise fund three or fund four or fund five.

Speaker B: Makes a huge difference.

Speaker A: I mean, if Arthur and company put in a million bucks in your fund and you've only wired him 50k and you're asking him for another million, it'll be a whole different conversation if you return him his whole million and you're telling him the fair market value of what you didn't sell on the secondary market is worth another two and we might even double. He's like, I'm, um, liking this fund. So we say, what happens when my direct fund buys 10% to 50% of the preferred shares you own and the ones that are going up the fastest and the most, let's get you to 1x so you can live to fight for another day. So the fund of funds, really, really

Speaker B: clever because basically what you've done is you put yourself into the winners. You've given them cash to give back to their LPs, that gives them confidence to jump into the next fund.

Speaker A: That's right. Am I getting it right? That's right. And then the latest thing that we're doing because we got excited by investing in SpaceX and OpenAI and Anthropic and Anduril and Replit and these kind of guys. We've said, why don't we create SPVs and make them available to RLPs to um, put money on a deal by deal into companies that look like they could IPO this year or next year. You know, and they are growing and it's a like generational thing to see companies that grow like these leading, you know, mega cap, privately held, you know, companies.

Speaker B: How do you, how do you source those shares without tripping? All kinds of shareholder company issues. Rofer, the stuff.

Speaker A: Uh, great, great question. So, so there's um, and people are, people that are financially literate on a lot of the economy, are extremely financially illiterate on this and they're actually shooting their brains out and causing self inflicting wounds without realizing it. Like a lot of like a family office out of Singapore says I want to be direct on the cap table. And I'm like, huh, huh? You want to be direct on the cap table of Anthropic? That means are you already on the cap table? And if they say no, I'm like, well this is just not going to happen. Yeah, you're going to spend a lot of time and the company has to give a permission. Like if you invest, if Arthur invests in my VC fund and you decide you want to sell it to your brother, I have to authorize and permission that sale right now. Your brother's not part of ISIS and Al Qaeda. I'll be good with it. But uh, it still has to happen. And when you're, and when, when you're a phenomenon like Facebook, Facebook didn't want to go public. They realized they were in violation of securities law, that they had more than 500 shareholders. They had thousands of shareholders, not just more than the 550 or whatever it was back then. It's expanded. The SEC expanded that. But um, you know, so number one is can you get permission, do you have written permission for the company to transfer stock certificate from this guy on the cap table to you? And uh, unless you are some wizard with a magic wand that delivers Indonesia or something like Tomas, not going to happen. You better be a sovereign wealth fund did not to get permission. Done that totally.

Speaker B: Yeah. It's just, it doesn't, I've seen it in action. It doesn't happen. Everybody's secondary this, secondary that. It just doesn't happen.

Speaker A: But you asked about Rofers, so let's say, let's say that you are to Masek and it gets permissioned and they say we want the sovereign wealth fund of Southeast Asia, Singapore in this deal and that's good. Um, then uh, everybody like me that has a major investor rights and has a right of first refusal, a rover I have typically like it could be anything from 30 to 90 days to either exercise my right of first refusal and buy the shares at the same price and terms as this outsider, or I have to waive my right of uh, first refusal. My Rofer. Would you want to negotiate with a company whose revenue was 2.3 billion in the beginning of 2024 did 25 at 275 million and in the first two months at 26 they're at 400 million revenue. Do you want to wait for 30 days for all the insiders who by the way have multi billion dollars of AUM to see if they can raise a special purpose vehicle to exercise their Robert, if you don't get Rofered, uh, the seller is not going to sell to you at that price anymore because their revenue is popping. And if you do get Rofered and most these companies have a roer price. So imagine Gordon Gekko is the king of the insider traders, who's on the board, who's been with the company since the beginning, decides to not row for you.

Speaker B: Yeah.

Speaker A: That means that they think that's gonna IPO at a lower share price. So congratulations for being the only person with conviction to think MySpace was going to be Facebook.

Speaker B: Right, Exactly. All right, so now tell us the secret. How you, how are you pulling it off?

Speaker A: Well, so, so there's direct to cap table where you need a permission for the company to move the stock certificate. Then there's, you know, the battle of not overpaying the ROER price or getting roared. And then you're dealing with people that have bigger access to money probably than you do and they have better information. It's like buying a used car. The seller knows if it was an in an accident and you don't. And who knows if he's telling the truth. Right. The thing to do is that you in a perfect world, a VC fund like mine, we funded the company in a primary, so we are on the cap table. We own the preferred shares. Then we decide we're going to sell 10% of this and 20% of that to return all the money to my LPs so that it's a walk in the park to raise the next fund. I'm highly motivated to sell something early and I love to Quote I, uh, quote in my book, the quote before my M and A chapter and my first book is I made most of my money selling too early, said JP Morgan. So I'm a big believer that there's a lot of wisdom in selling too early. And so we're highly motivated to sell something. But we don't want a negative signal that Seven BC Venture Capital is selling right before the IPO that could be material and go into the actual S1 and we're damaged. A lot of people are going to get very upset if they see us selling. So we typically would make a special purpose vehicle that's underneath the same fund structure and we sell the shares to the SPV, but because the stock has

Speaker B: new LPs in it.

Speaker A: Yeah. And then, and then a subset of the LPs in our fund have first crack.

Speaker B: Yeah.

Speaker A: At buying that. And so I actually say to my LPs, Hey Arthur, do you want. I, uh, just sold 10 of our position in this mega cap company that we were in at nothing. Uh, option one is I make a cash distribution to you. And I'll remind you that I've returned the whole fund now. So I, I don't want spousal blocking on you re upping in the next fund. And option two is you're like, if the company's raising 100 million round, they're going to double revenue, uh, in 12 months. They forex revenue in the last 12 months with very little money. If we drop 100 million of funding, it's going to do more. Recycle me into the SPV with no fees. So that's, and there's no tax. So that's option two. Option three is I recycle you. And you're saying I want to invest now that the huge crossover funds are in this, they're going to invest in the IPO and hold it for doing nothing, like hedge fund people. So I want to recycle and I want to put money into the SPV. Then a year later the company is 4x in value and you're thinking, I'll take my SPV money out, my principal money out, uh, my principal money out, and we make another spv. So in the parlance of the secondary world today, people say direct to cap table and I'm either invested in the primary or I bought preferred shares on the secondary market permissioned and didn't get roared. And you better make a case. Nobody, uh, wrote for these people. We like them. The second thing is that your L1 layer one special purpose vehicle SPV that gets distributed the shares when everything goes to common after the ipo, or when there's exit consideration. And so this is worth knowing. I don't think most people understand how layer one, layer two works, that when there's an M and a exit, and it could be all cash, it could be a loan and interest and really complicated. When the exit consideration is paid to the shareholder if they have a properly drafted legal agreement with the spv, which they might be the sponsor operator of. In an ideal world, that the exit consideration is paid from the fund that receives that money to the spv, and there's no Zuckerberg that can stop that from happening. Then if you had a layer 2 SPV, which could all be just 7 BC. 7 BC. 7 BC my fund, my firm. Or it could be somebody else. You know, it could be Arthur's Roundtable spv. You make an SPV because we're friends.

Speaker B: Totally.

Speaker A: And we. Hang on. And then you go and raise some money to, uh, buy out our layer two. So there could be three layers. The big question, people, a civilian says, I don't want to be in a layer three. I don't do layer three. I only do direct to cap table. Yeah, I'm like, you're shooting yourself in the head. You.

Speaker B: Yeah, not only that. Move on, like, if you don't get it. So here's, here's another question, right. Uh, super smart, by the way. I like it. Um, how do you get to a price to sell the shares to your fund of, uh, the shares that you have of that whatever it is to the spv? Where do you get that valuation?

Speaker A: Great question and a really clear answer. When we're selling to ourselves, we go with the share price of the financing. So if, if we put in, you know, money on a convertible note or pre or post money safe, and then it converts into series A preferred. We have a price per share. Then we're probably not doing a secondary after that yet. We're up, but we're not up enough to be selling. And then we're up a lot. And we're saying it would be irresponsible to not, uh, try to 1x our fund with a. Selling a little slice of a few things here. And so the best thing to do is to sell our shares to the new big vc, who's all hot and heavy to increase her ownership percentage. There's people with like 3 billion fund, or they got like 80 billion and they've set aside 6 billion to cross over and buy into private markets. I mean, that's like bigger than NEA. They raised 6.8. And half of that was a CV continuity vehicle. Half was their seed fund of 3.8. This guy's got more than that just for privates. And it's a drop in the bucket compared to how he gets paid for just holding Microsoft stock.

Speaker B: And then is the, uh, you've basically obfuscated the, the nonsense of trying to go direct. So the argument, like you said, shooting yourself in the head to go direct, just not going to happen. You could burn up all kinds of galleries, all kinds of legal issues and you'll never get there.

Speaker A: The thing to do there is that, um, if you're a big enough check writer, try to get in on the primary. And one way of doing it is that we might have said we've already got 15% of our fund in our winner. Remember we talked about like logo loss versus percentage of the fund loss that we might have hit by portfolio, construction and spreadsheet. We feel stupid. We might have even stated in our operating agreement we will not put more than 15% of your money into one asset. And then now I've got a pro rata to invest 50 million in the next primary and I don't have the money and I haven't raised, uh, enough and I'm struggling to get that money out. Say to, you know, friends of mine said, does anybody want to invest in the primary? Yeah, so put money into an spv. And then I put the money right in the primary and now you're, you're good. There might be a senior liquidation preference for the last round. Like I have no idea. But I wouldn't be surprised if the 110 billion that's going into OpenAI gets paid out before anybody else. Anybody else, which only matters in a world of M, M and A. And the only exit for that company is ipo. So that means nothing because everything will convert to common.

Speaker B: And then from the economics and uh, this is in the spirit that it's meant that can you make money on the spv? Just your carry there. Is that enough money for you to make on the spv?

Speaker A: So people are doing this in different ways. And I'll tell you, like what, what is happening is that some VCs will say, I bought shares in Anthropic at 5 billion and then I managed to raise an SPV to be in the primaries. And frankly, um, I'm investing at the share price that the board has agreed to issue stock to, you know, approved primary investors, right, to fund the company. But I'm going to use that stock price to sell some of my shares that I bought at 5 back then. So we're rate they raising at 350 billion. He was in at 5. He's gonna sell, you know, he's gonna sell some shares there kind of like at that price.

Speaker B: Yeah.

Speaker A: Um, in that case he's selling shares at a gain he's selling at either 350 or 380 billion where his cost entry point was 5. So you would think that this person would say, I'm happy with the gain I've made for my LPs, I'm making a distribution and I'm in carry. Yeah. Uh, but you'd be shocked. These boys are greedy and they actually say, Andrew, I'll sell it to you at 380 and I'm taking a uh, 4% fee if your SPV check comes in below 50 or a uh, 7% fee if it comes in below. We might negotiate that down to 5. And I want a one time access fee of 4 if it's above. So he's actually as they say in New York, getting paid, coming and going there.

Speaker B: Yeah, I'll say, wow.

Speaker A: But, but we might have been lucky. We might consider ourselves lucky to be getting that deal.

Speaker B: Just like Stevie Cohen, you know, charging 5 and 40 because he could.

Speaker A: Right, right, right. And then you got uh, what I call the broker cesspool. And that's like a daisy chain of somebody, you know, has an MBA from some school and he puts in the chat, does anybody know anybody?

Speaker B: Oh yeah, man.

Speaker A: And then all of a sudden you're talking to people that they say, I

Speaker B: have enough for that to happen.

Speaker A: Say what?

Speaker B: You never live long enough for that to happen.

Speaker A: Well, you know, I remember I was actually trading secondaries under a BD back in like 2006, if you can believe it. And like at one point we had somebody calls me up and said, hey, I see you're friends with Brian Cohen because you guys were on stage at some event. Could you ask, uh, I know he's the original angel investor in Pinterest and you guys look like you love each other. Could you get me, I have a buyer who wants to buy 200 million at Pinterest and we want to do a 50 million purchase first. And if that goes through like proof of life, like a bitcoin trade, we'll immediately do another 150. So I call up Brian, we get it Together, we have 200 million of Pinterest inventory to be sold. And then later that afternoon I get an email from. From the same guy saying, I have 200 million of Pinterest and we want to sell 50 million first. Like, you're trying to sell me the dope. I'm your drug dealer. I'm your source. Where do you think you buying this stuff? It's from me. And I was like, have a little bit of, you know, organization to not email me that.

Speaker B: Yeah.

Speaker A: And so he was phishing for inventory when he had no buyer, and now he's going to run around saying, I got 200 million of Pinterest. I'm going places.

Speaker B: And.

Speaker A: And so a lot of times the buyer doesn't have it, or someone tells them, uh, how much, uh, anthropic have you got? You're like, 50 million. They're like, I'll take the whole thing. I got a buyer who wants 250 million. It's like, do you are. You do show me proof of funds?

Speaker B: Proof of funds.

Speaker A: That's all crickets. You're never going to get it because he doesn't have proof of funds. And he knows a guy who knows a guy who knows a guy who. Who's lying, who's fishing for inventory.

Speaker B: Yeah, exactly.

Speaker A: Uh, so it can get very, very messy. And I would say on the L1 L2, you know, if. If the guy operating the, you know, not to pick on it. Name a city in a country you don't want to be in. If that's this, you know, if it's. If the. If the SPV layer is in Tehran in Iran right now.

Speaker B: Yeah, yeah. Ah, yeah.

Speaker A: Am I really going to get paid when the exit comes through? So the reputation of each SPV manager starts to become very important.

Speaker B: So, uh, I have a story that sort of smokes these things out. I had somebody come to me that owned a building in Brooklyn, built it up, wanted to take some money off the table, said, you must have some family offices that want to, you know, take $10 million off the table for me. I said, yeah, I probably do. Uh, I said, okay, so here's my agreement. And the agreement basically said, there's a fee for me bringing people to the table if they trade. You know, my fee is x, and if you don't pay me, the penalty is 3x.

Speaker A: Like a breakup fee.

Speaker B: Yeah, it was basically, if I have to sue you to pay me and I win, then you have to pay me 3x my fee.

Speaker A: Getting paid is an important part of the puzzle in investment banking.

Speaker B: Here's the reveal, right. Is when I sent that agreement to him, he said, well, I don't want to pay 3x if I don't pay you. And I said that. You just told me you're not going to pay me.

Speaker A: Yeah. That's a very interesting clause to test people out.

Speaker B: Right? It's just like. So that was the end of that. So, listen, I got a hard stop, and we could go on forever, but can we do this again soon? It's my fault it's been so long for us to do this, but I think this has been a great conversation for me. I think the audience will enjoy it as well and always enjoy chatting with these smart things with you, of course.

Speaker A: Me too, I think. Great to see you. And I hope to see you, uh, very soon in person. Yeah, we're gonna.

Speaker B: We're definitely gonna get to Austin for sure. But come.

Speaker A: Okay.

Speaker B: I want to get out to see you.

Speaker A: Okay. Bye for now. See you next time.