Venture with Grace
00:10:32 · Jay Zhao
[00:10:32] S1: So the question is that how companies position ahead of the curve, which impact when it's not something most of these pay attention to. I guess the question is how do we think about the regulation and the impact on AI companies? I think when we think about there are certain areas that are very high compliance driven, right? Healthcare, finance, legal, those areas are vertical AI companies that have much more either headwind or tailwind when there is a regulation change. At the same time, most of the companies that you see in the AI application side that's really kind of breaking out over the past few years. Harvey of the world, OpenEvidence of the world, they are still trying to solve the problem that's a little bit distance away from the regulation. In my major career, we try to stay at the application level. So we don't really I guess if one regulation need either become a breaking or making factor for a company, it's probably the type of investment that we do not touch anyway Because the underwriting risk for VC, the underwriting mechanism of VC is really about one, does the technology work? And two, is the right team to build this technology and bring it to the market? And three, is the market growing and will be growing further? I think ranking wise, those are the three criteria that's most important. And the regulation piece, if the regulation piece comes at the IC meeting and becomes a huge debate out of the three factor, typically I think, at least for us, we try to stay away from that because we just don't understand how the regulation will change one way or the other. But I do think I talked to my friends who are running hedge fund and private equity fund. I think those type of companies, they will have much more immediate impact, negative or positive, based on regulation environment. Yeah, I don't know if that answered your question, but that's kind of how think about all these companies.
00:12:44 · Grace Gong
[00:12:44] S0: Is there like, so I want to start with the fund aspect as well. Since like, know, I believe your first fund was like $10,000,000 and 7,000 was like $25,000,000 and maybe we can talk about like the portfolio construction. I feel like the smallest track you guys wrote is like 25 ks to like later, I guess like, I don't know what is the biggest trend, like, know, I'm sure it's like probably closer to like millions or something. How do you think about leading in the aspect of, I know that you guys lead deals and in the like a era, I feel like a lot of the companies are raising, you know, like we had like the fund of core automation in last week and then he raised like 532,000,000 for seed. So when you're looking at these like crazy rounds, like how do you think about leading or, you know, just like Yeah. Just be like, you know, like a participation like track into the company and what kind of ownership are we targeting since I felt like the labs era is kind of coming to an end. Now it's like everyone's investing in different agent or sector specific companies or in general. What is something that you personally feel like feed into your thesis? Yeah. No,
00:14:02 · Jay Zhao
[00:14:02] S1: it's a great question because we're at the tail end of wrapping up all new funds. So we've got this question a lot, especially from an LPs perspective. I can understand it's quite confusing, you know, like how do you actually gain position, do you actually get the right entry evaluation point. For Hong one, we started with 10 because we just wanted to see if our thesis work, like how our methodology works, right? So anything that we write between like a 100 k to 200 k type of check, consider a core position for that fund and MaintainX was in that category, Spectro Cloud within that category. Our idea is that can we consistently, using a concerted approach, consistently find the right company and get access to it and invest in it and make a good relationship. Fund one turned out to be a really good fund to this day, five years in. Fund two, our AUM is actually 40,000,000, so it gets a step up a little bit. Then the idea is that, okay, so now Leonis has some brand. It's not fully established yet, but can we actually find maybe 20%, 30% of the deal that we can lead or co lead the round, meaning that the audience will have 5% or 10% ownership. And we execute that over the past two to two and a half years. So what happened is that heading to this year, the market becomes super hot for various reasons, right? The AI boom and then the inflation and all that stuff. And it definitely rhymes with a a 2021 vintage. 2021 is very high of the year as well, high valuation. It's just different engine, driver behind the scene. In that time, twenty one, five years ago, the driver was a stimulus plan, the zero interest rate, the people was interested in SPAC, all that stuff. So we're seeing a similar environment right now, but right now the driver is different because people just want to invest in AI companies and AI stock and, you know, chasing the AI boom. It does present a challenge across the board, I would say, for VCs. But one thing that I worry a lot more about is legacy side. Because if you think about the companies that got SPAC listed in 2021, and a lot of companies get high valuation at growth stage in 2021, a lot of these valuations got slashed 50%, sometimes 70%. And a lot of companies either they just could not raise full on capital or they just kind of went down or whatever, right?
00:16:37 · Jay Zhao, Grace Gong
But nobody talked about it because it's not a good story, not a flashy story, but it does happen. So I think if the market work on its own mechanism and work the way it's supposed to be, that's something that we would pay attention to heading into next year. To answer your question, for Fund III, we are wrapping up $75,000,000 fund. [00:16:59] S0: Congratulations. Oh, thank you. I feel like raising money in this climate is a challenge for everyone. [00:17:07] S1: Yeah, it definitely is. One raised one to you was challenging as well. [00:17:13] S0: Do you feel like raising a $75,000,000 front cover to a 25 is a different set of challenge or like it's kind of the same because we kind of like up your game as well. And then the better performed company is kind like a more like obvious to the universe. Do you feel like it's the same kind of like difficulties or like do you feel like it's like it's because the number is Vanguard, so it's like Vanguard? [00:17:36] S1: Yeah, I think each vintage or each fund sequence has its own challenge or benefit, if you will. One thing I didn't appreciate or didn't realize is that how much VC fundraising is actually tied to the macro market. [00:17:53] S0: I think it's all about the macro market, right? I know. Yeah, I feel like it's all about if you tap into some sort of huge trend.
00:18:01 · Jay Zhao
[00:18:01] S1: Right, yes, but the other thing I did not realize heading to Fund one and Fund two fund raise is that it's so tied to the interest rate because it dictates the capital allocator whether they want to invest in private side or not. So in Fund two, the reason it was hard is because the interest rate was super high across the board, So people don't want to invest in private sector, period. They'd rather park their money at some saving account. So for Fund III, I think it really had to say to our founders, MaintainX has good exit, so they returned Fund I multiple times already. And Venture performed really well out of Fund II. And all that happened around the same time. So when we go back to our LPs and talk about our strategy, how it works, and then forward to a five year mark and two year mark, it has pretty clear evidence that something's working. One thing that we of the LPs actually talking to us about this is that right now AI, at least for the better part of this year, has been really hot. And he was saying that if you guys keep the funds openly longer, can you raise $200,000,000 of funds. And he has seen multiple cases like that. And I have seen my GP's friends do that as well. I think one thing that we don't want to do is that we don't want to change our capital raising cadence because the market is hot. Because I think that's the easiest mistake, very tempting mistake to be honest, because if you rack up your AUM, you have more fees and so on and so forth. But I think both Jay and I, we kind of talk about this, like this is a long term game, right? So we would rather make sure that each fund returns the capital return at the top tier level. We're not going anywhere, right? We can raise fund four and fund five and kind of gradually scale up AUM from there. That's how we think about this. But the other thing I do think is presented a challenge is that where do we sit as a $75,000,000 fund in the ecosystem, right? I think one of the things, I was kind of talking about this, if you raise a $200,000,000 fund, $300,000,000 fund, at Fund three, or even at Fund one, the challenge is that you're competing with more established names at a Series A stage.
00:20:15 · Jay Zhao
And that's a terrible space to be in right now because Series A typically meaning that the company already have product market fit, something's working, and then you're competing with probably 10 or 15 other term sheets. Whereas if we stay below 100,000,000, we think we can still make meaningful impact to the founder's journey before they find product market fits. That's why we say we're a specialist at VC to C stage investing and that's kind of where we think the high alpha comes from. But yeah, it's tough across the board for both VCs and maybe for founders as well because everybody is racing new around, high valuation, and everybody has a huge war chest these days. So it'll be interesting to see how it unfolds in the next few years.