Siddhartha Ahluwalia 01:00

Hi, this is Siddhartha Ahluwalia. Welcome to The Neon Show. I’m so happy today to bring a very special guest on The Neon Show podcast.

Today I have Hunter Somerville, partner at StepStone. They are one of the largest fund investors globally and have more than 600 billion in capital responsibility and over 100 billion dollars in AUM. And Hunter has been, you know, previously with Greenspring Associates and currently, you know, Greenspring got acquired by StepStone in 2021.

Hunter, welcome to the podcast. So excited to have you today on The Neon Show.

Hunter Somerville 01:40

No, thanks for having me. Looking forward to it.

Siddhartha Ahluwalia 01:42

Hunter, I would love to know about the history of StepStone first.

Hunter Somerville 01:48

Happy to, yeah. No, and I’ll cover it a little bit more with a Greenspring lens because that’s what I’ve been a part of and then can tell you about the journey post-combination as well. So in terms of my history, I joined the firm in 2011.

Greenspring had been around back to 2000, 2001 when things got going. Firm was founded by my partner Ashton Newhall at that point in time, who was a third generation venture capitalist. And he decided to put together a more unique fund of funds back then that included fund direct and secondary investing, instead of just focusing on fund investing exclusively.

And so from there, over time, we’ve become much more of what I call a multi-strategy venture platform. So we don’t even define ourselves really as a fund of funds at this point. And we are active across fund direct and secondary investing and have evolved how we do each of those over time as well.

Like I said, I joined in 2011 originally as an associate on the team, and over time became one of the partners of the venture group. And then about two and a half years ago, we made the decision that for the next part of our journey, it would be really interesting to be part of the larger StepStone organization. And StepStone itself is a public company.

It has a variety of different asset class teams that do different things in different areas like real estate or private equity. And what my group does is venture and growth equity, because that’s what we’ve always done. That’s where our expertise is.

That’s where our network is. And we combine together with the folks on the StepStone team that we’re doing venture and growth to produce what we think is a really interesting go-forward offering, both in terms of team and what we continue to do across fund direct and secondary investing.

Siddhartha Ahluwalia 03:44

And how big of a venture team does StepStone have right now?

Hunter Somerville 03:49

The venture team is over 100 people.

Siddhartha Ahluwalia 03:52

Wow. And how many managers do you manage on the venture side today?

Hunter Somerville 03:56

So in order to fully answer that, we have to factor in what we do on the discretionary side of our business and then also what we do in separate account and advisory work.

And that number of venture growth managers is over 200 at this point. And so we have very comprehensive global coverage of venture and growth equity, which is very different, I think, from others who are only doing a handful of managers and working with them because of the way that we’re set up we’re able to work with a much broader swath of the venture community.

And that includes people on the seed and micro side up to people that are doing crossover strategies. And you can imagine that that allows us to have pretty interesting sourcing channels for direct and secondary when you’re working with all different types of managers. And that’s just from a stage standpoint.

If you layer in what we’re also doing in terms of industry specialists and geographic specialists, that gives us a pretty interesting perspective and purview across the entire asset class.

Siddhartha Ahluwalia 05:00

And would like to dive into more of this. What makes StepStone so special, so different from other, let’s say, on the fund of fund side?

Hunter Somerville 05:10

Yeah, I mean, what makes us different is that we’ve always taken a platform approach to what we do. So we’ve never wanted to be defined as a fund of funds. We’ve wanted to be defined as a platform.

And the fact that we’ve included direct and secondary investing from the very beginning is important because that in our opinion makes us much better as fund investors. When we’re evaluating a fund, we are taking a much more granular asset by asset point of view on what our managers have done. We’re looking at those companies.

We’ve generally, you know, diligence many of them if they’re more advanced and have hit growth stages. We have a point of view on what we think future value could look like in unrealized positions. And so as you know, in venture, it takes a long time to eventually get to a realization.

If you’re waiting around and just judging what people have done on a realized basis or in DPI, you’re not going to have a good sense for the momentum in those managers, and you’ll probably wait too long to eventually pick a really interesting up-and-coming group.

So we use the direct lens in order to come to a better opinion on who’s doing well or who isn’t doing well. And on top of that, because we do direct investing, we’re oftentimes board observers within companies, and we actually see the managers in action.

So you see who comes to board meetings and who has nothing to say or isn’t adding value or doesn’t even show up to board meetings versus those that are actively involved, strategically giving advice, providing customer introductions, being a really hands-on collaborative partner to founders.

And that’s better than any reference call you’ll ever do, because with references, people are inclined to always say good things and not give you a great sense for who’s additive or make comparisons between board members. We see all of that in action.

Similarly, with the secondary side of our business, secondaries are really fund investing or company investing, because we do both. That reinforces, again, everything we do from a diligence standpoint. And so we think we’ve built a fly trap and a model that is really different because we’ve included all three of those from the very beginning.

Siddhartha Ahluwalia 07:23

And how are your 200 active managers split geographically today?

Hunter Somerville 07:28

So it’s still a very high majority U.S., a decent majority there. Outside of the U.S, over time, we’ve been active all over the globe in what you would say are the relevant venture ecosystems. We’ve been investors in India for a long period of time.

We’ve more recently done some commitments in Southeast Asia. We have done investing in China going back to the beginning, although that’s tapered off more recently. We’ve been investors in Latin and South America in a smaller way, Europe and Israel for a long period of time also.

Siddhartha Ahluwalia 08:04

And if you will have to summarize, what would be the smallest fund that you have backed in size and what would be the largest fund?

Hunter Somerville 08:12

Smallest fund would probably be around 40-ish million in terms of size. Generally, on the smaller end, we’re coming in with fairly sizable commitments. And so we need to be cognizant of what percentage we represent of a fund.

And we’re OK being a pretty large percentage. But we also want to set the manager up for success and have them diversify by LP type and not be too concentrated with one group. And so need to be thoughtful about what makes sense for the GP as they continue along on their journey.

On the larger end, we’ll go into funds that are in the billions of size. Those are oftentimes more specifically oriented towards the advisory side of our business who are looking to invest larger check sizes, but also periodically done through some of what we do on the discretionary side also.

Siddhartha Ahluwalia 09:07

And can you tell us about the process right from the beginning? How have you added, like at what pace you have added managers each year? And how has that changed over recent times?

Hunter Somerville 09:19

Yeah, so I think we are always known for being pretty active with new and emerging managers. That’s something that we take a lot of pride in.

And we do that both on the seed side, on the spinout side, and then also on the bootstrap growth equity side. I’d say those are the areas where we’re most active with new managers. Specific to micro, as you know, there is a long tail of groups in that category.

I’ve seen estimates between 2,000 to 3,500. And so that is a lot of work and effort to meet with everyone that’s relevant out there. Our point of view is we should get to know people at the very beginning of their journey.

It doesn’t mean that they’d be a fit for us naturally up front, but we want to begin to build that relationship and develop pattern recognition and see how they’re performing in an iterative kind of way. So we will literally meet with everyone out there in that category, and begin a ranking system.

And at the end of day, we’re not going to have that many slots per year to add, but we will begin building those relationships and try to force rank and winnow that 3,500 down to a few that we do on a per year basis.

In the growth equity category, and I think this is an area I increasingly think is pretty interesting, bootstrap growth equity, you will see spinouts periodically each year. It’s not at the level or quantity of what you would see on the seed side, but you see folks leave growth equity firms that have gotten to 500 to in the billions of size and have decided they’d rather do something in the 100 to 300 range and be able to focus on businesses with 2 to 5 million of ARR and do it in a more reasonably sized fund.

And those folks generally have pretty good pedigree and there’s not as much competition as you would see on the micro VC side. So we like that area as another vein to potentially explore.

And then the third category would be someone that leaves an established multi-stage platform brand and decides they want to do something more focused and probably more early stage from a purity standpoint, and they leave and decide to do something in the 200 to 400 million dollar size range and build sort of a smaller, more focused, earlier stage version of the place that they were at before. And so those can also be pretty interesting opportunities for us to pursue and consider.

Siddhartha Ahluwalia 11:46

And what would you say where the bulk of your managers lie? Would it be on the growth side, on the medium 200 to 400 side or less than 200 side?

Hunter Somerville 11:56

Yeah, I mean, it depends how you define that by capital or by quantity. But I would say growth equity is still a smaller segment. There’s just not as many groups that we think warrant doing, which is why it’s also a persuasive opportunity.

Within the rest of our book, we are very biased towards early stage. So seed and series A has been our approach and where we’re the most comfortable.

Siddhartha Ahluwalia 12:26

And that means that less than 400 million fund sizes has been the preferred?

Hunter Somerville 12:32

Yeah, I would say that that is the preferred. But we also continue to think that there are very interesting platform brands that do a very good job across stages and have built that brand recognition. And particularly when you look at series A, those groups always maintain an advantage.

It’s just a question of how that corresponds with fund size and how that corresponds with other parts of the platform and what that mix looks like at an aggregate level when you analyze it.

Siddhartha Ahluwalia 13:03

And what is the percentage manager churn that StepStone has and what has usually led to StepStone churning a manager?

Hunter Somerville 13:10

Yeah, the churn percentage is pretty low at this point with what we do, but we have different ways to invest in people, as I described, whether that’s specific to certain strategies or other clients that we work with. And so it does allow us to add people in different ways than others maybe could. What would lead to it?

I would say significant team change where we see failed generational transition, where we see that spin-out activity that I just referred to, where people leave and decide to do something new.

And if you then see the interesting younger cohort of the firm leaving, you recognize there’s probably some level of internal dysfunction or a lack of sharing of economics or some dynamic there that breeds or suggests organizational issues that we wouldn’t be comfortable with. And so that would be one thing.

The second would be performance. If I go back to what I was saying on looking at asset quality, on thinking through future performance, if you see that type of degradation within the portfolios on an unrealized basis or the quality just not be very high, that’s something that we wouldn’t get comfortable with. If we think that someone has gotten too aggressive on fund size appreciation, that is an area that we’ll often scrutinize.

And the math just gets harder when fund size gets larger. If someone changes terms too significantly, if we don’t feel like the economic splits make sense and don’t reflect who’s providing the biggest contributions, and that doesn’t evolve in a way that we’re comfortable with over time, those could be other reasons for disqualification.

Siddhartha Ahluwalia 14:56

And how has your relationship with India been and who was the first manager that you backed in India?

Hunter Somerville 15:00

So we’ve been investors in India for a while going back to pre-2010. I think the first manager we invested with back then was Nexus. Ironically, I was just at their annual meeting this week, so they’re top of mind for me

And we’ve been active investors since then. I would say we’ve had sort of crises of faith around India over time where DPI and realization activity has been an issue that has always been discussed and where we’ve wondered if that would improve over time. And I would say probably within the past three years, we’re near the most optimistic we’ve been around that.

And we can talk about why we think that that has gotten better and why that’s changed. And you probably have an even more nuanced point of view on that than I do. But I think you’re finally seeing really good DPI performance and numbers put out there through a combination of domestic IPO efforts, through some M&A, and then also through more creative secondary structuring, which is obviously close to our hearts and our experience and expertise.

Siddhartha Ahluwalia 16:10

Well, we’d love to know about after Nexus, who have been the subsequent managers that you have backed in India?

Hunter Somerville 16:16

I mean, we’ve done a number of different groups in India. You know, I don’t know that I can name all of them just from that standpoint. But what I will say now is that we are most focused on the smaller end.

So I think we’ve got some of the best Series A performers in our portfolio that are out there. And where we’re thinking now is who makes sense to back that’s more Seed, early Series A that is, you know, in that kind of sub $300 million category, because many of the groups that we backed at the very beginning have now scaled to the $400 to $800-ish range.

And we’d also like to complement that increasingly with groups that are $300 or less, just to provide sort of both ends of the barbell, I would say at this point.

Siddhartha Ahluwalia 17:08

Some of the managers that I have known and spoke very highly about StepStone. The kind of relationship that you have with your GPs, for example, Stellaris has been one of your recent managers that you have backed in India. And previously to that, you have been backing Lightspeed and Charate also. But there’s a special relationship that you share.

We’d love to know why that is so? And how do you get so much preference once a Series D or Series E is happening? I have examples.

Hunter Somerville 17:37

Yeah, so Stellaris is actually probably the newest commitment in India. And, we literally have just done diligence work on that one. So pretty top of mind.

And I think it speaks to what I just said, finding someone that we think is a really interesting up and coming performer, with a fund size that’s smaller, with portfolio construction that also corresponds to that. And so we are excited about what they’re doing. Specific to your question.

Sorry, go back to what you, oh, the relationship part of it. Yeah. I think that’s something that we think about across our entire platform.

We want very hands-on relationships with anyone that we work with on the GP side. And it’s because we do secondary and direct investing alongside them. Because we take advisory board seats on pretty much everyone that we work with.

We want to be that thought partner with everything that they’re doing. We want to be a thought partner potentially on investing alongside them as companies reach early expansion and early growth. And they’d like someone that allows them to do more and get aggressive and go pro rata, super pro rata with an aligned and thoughtful and flexible partner.

As I was just mentioning, from a liquidity standpoint, there’s going to be a time where maybe they can’t generate all of the liquidity as quickly as they would like. And they’d like to consider doing a strip sale or a CV or a tender offer or something to provide liquidity optionality. We can come in and do that.

And beyond that, we want to be a good partner as they think about building their business. And so thinking through the right decisions to make, the tough decisions to make, how to think about things on the team side, team additions, and everything that comes up on the journey along the way. LPs that they may want to add, introductions we can make to our LPs or introductions we can make to LPs within our broader network and community.

Our goal is to set these managers up for long-term success because that’s beneficial to them. And it’s also beneficial to what we’re looking to do from an investment standpoint. And I think we tend to be one of the most hands-on partners in a good way.

If you were to ask our managers out there in terms of the different ways that we can add value and be additive and helpful.

Siddhartha Ahluwalia 20:06

Yeah. And I have a few examples, for example, you led the last round in Zepto, right? When it became a unicorn and it’s a Nexus portfolio company.

Recently you have led, I think, a $150 million round in PocketFM, which is a Lightspeed company. Tell us more about that. How do you take those decisions in India, deploying such large pools of capital?

Hunter Somerville 20:30

Yeah. So Zepto we led, Pocket we participated in. We weren’t the lead on it. And we can do either. We have no ego around this. We’re not looking to have to be the lead.

As I mentioned, we’re generally board observers on the companies that we work with. Our view is we always want to be a flexible partner, both to founders and to GPs. So we’re really looking for situations where our GPs are incredibly excited about a company and are reflecting that through actual deployment of capital.

People can say they’re excited and thrilled about a company and they’re doing pro rata or less than pro rata. We’re looking for scenarios where they want to cross it into a growth fund or where they want to invest a really meaningful amount of capital.

Our model has always been to use the informational relationship, the informational advantage and the relationship advantages that we have to identify the best companies ahead of time, to build relationships with founders through warm introductions from the GPs and then position ourselves to lead those rounds as a preferred partner and a known commodity to the existing board and hopefully to the founders because we’ve done that work ahead of time. So those are the scenarios we’re looking for.

There’s tons of interesting companies out there that would never be a fit for our model. We’re not trying to boil the ocean. We’re trying to throw spears in a more concentrated kind of way and utilize the relationship and informational advantage that we have to do that.

And so that allows us to put together a tracking list of companies within our manager portfolios that we like, get introduced, see when they’ll be back to market and then start building goodwill with the companies through the utilization of our portfolio impact team that makes customer introductions, selectively helps with recruitment and talent assistance and do that ahead of time because even if it doesn’t materialize into a direct investment for us, it’s still a meaningful investment in one of our funds that we’re already an investor in.

And that breeds goodwill because hopefully it improves the performance of the fund. It also shows the managers that we’re more than passive capital. And if they are successful and if they become access constrained over time, they’re going to know that we’re doing a lot more than other people that are just giving them money and seeing them at an annual meeting every two years.

It’s a much different value proposition to the GPs when they’re making the tough decisions on allocations for the LPs.

Siddhartha Ahluwalia 23:02

And now I want to reiterate one of the last points that you mentioned that you have been more excited about India in the last three years than ever. Why is it that?

Hunter Somerville 23:12

Yeah, I mean, I think when you look at India specifically, the biggest holdup has always been, can you get capital back on investments that you’re making? And from an IPO standpoint, while it’s not at a fever pitch yet in terms of companies being able to go public domestically, it’s certainly improved.

And from our interpretation, it feels like companies are able to go out at a smaller top line scale than you would see in international markets where it’s viable, maybe in the 100 to 150 million top line range instead of what seems to be more like 200 to 300. The U.S. barometer for what’s required to go out just keeps going higher and higher for a number of reasons, which means companies are staying private longer and longer.

In the Indian market, lower top line, although probably more of a desire for profitability at time of exit and IPO, which I think is actually healthy and fits the market that we’re in because investors would like to see profitability or very proximate closeness to being profitable, and that will breed increased comfort as well. And so you have the ability to go out domestically in those situations, or you could do a global IPO independently.

On top of that, M&A optionality seems to be increasing, and you have the ability to consider secondary solutions. And we’ve been in discussions with a lot of managers in India increasingly that I think are exploring that, and they’re either selling single positions to folks like us who do secondary investing, they’re selling to private equity or other financial buyers, or they’re considering more whole-scale secondary solutions where they would do a continuation fund and provide that as an off-ramp or probably less strip sale.

But I think you’ll see more of that as well, where they consider just selling an entire swath or strip of the portfolio. And if all of that becomes viable and you actually have DPI metrics that are as attractive as the TVPI metrics we’ve seen for a while I think that becomes very different.

The other thing which is probably more relevant to you is I think the cross-border SaaS efforts in India are very interesting and also are viewed very differently than purely domestic efforts in innovation in India. And when you look at cross-border SaaS, that’s really more of a global perspective on investing. And so I think it ties to managers in India and gives them an advantage at earlier stages.

But you’re going to have significant capital that wants to come into those best-performing businesses once you get to C, D, and E. And no one then thinks of those as something that they couldn’t do, which means there’s a plethora and abundance of growth capital. I mean, there’s not a plethora and abundance of people deploying, I’d say, except in the best companies in this macro environment.

But that kind of profile of business is highly desired by all kinds of international allocators at this point. And India plays an important part in that from an early stage standpoint. So those have all increased our overall interest in the geography specifically.

Siddhartha Ahluwalia 26:54

And if I had to summarize, India would be what, three to five percent of your capital portfolio?

Hunter Somerville 27:02

That’s probably a fair assumption, but I would say on the fund side, because we’re beginning to be more active on the direct side. So it would not be that hot yet. And I think the secondary side is still developing.

And so I would think of it more from a fund standpoint at this point. But we are very excited about the direct growth and secondary opportunities that we think we’re just at the beginning of.

Siddhartha Ahluwalia 27:35

One area that I want to dive deep into is that you only do direct when one of your existing managers is in the company. And India, I believe you have a single digit relationship. It hasn’t crossed two digits yet. So how do you want to do that?

Hunter Somerville 27:56

That’s correct. And in my point of view, you know, I would rather remain concentrated. We’re not going to suddenly have 20 to 30 managers in India.

That’s not our desire. And I don’t think there’s 20 to 30 that we would view as worth doing at this point in time. And so it will always be well, I won’t say always, but I think it will remain a more focused strategy.

And because we’re investing in who we think are some of the best groups doing seed and series A, that should have good correlation with the companies that we would ultimately want to consider once they get to B, C and D.

And unlike others, you know, we have much broader coverage, you know, in terms of manager count than your typical allocator that would be doing it in a more focused way. So we don’t view that as limiting.

It’s never been limiting in the U.S. It’s allowed us to maximize our bandwidth in a way that is probably most advantageous rather than talking to any company that’s out there. It allows us to put together really focused tracking lists of what we should or shouldn’t be considering. And it would be the same in India.

We are adding new managers versus the ones that we’ve done. So it’s not saying static, it’s not going down. And as we do a little bit more in smaller and in seed, I think that will open up the aperture further.

But that’s never going to change, at least in my opinion, where we start doing random company investments. We want to filter the universe this way. We think it both de-risks opportunities and maximizes upside.

And that’s our model. That’s the power of our model, it’s the deep and ingrained network we’ve built across the ecosystem with the approach that we have towards manager allocation.

Siddhartha Ahluwalia 29:50

And do you have any managers which are, let’s say, less than $100 million in India today?

Hunter Somerville 29:56

No, we do not. I think we have one between $100 and $200 million, but not sub $100.

Siddhartha Ahluwalia 30:06

Sure. So your preferred range in India still would be between $100 and $300, I would say.

Hunter Somerville 30:15

We’re open minded to someone that’s $50 to $100. If we think that there’s a track record that we can get comfortable enough and where it shows outperformance and some really defensible advantage, it’s not a definite no. I think what we focus more on is probably folks in that $100 to $500 range.

Siddhartha Ahluwalia 30:42

And how has your capital split been across direct funds and secondary till now?

Hunter Somerville 30:48

Secondary is the biggest thing that we do at this point. But each of those are very meaningful and important components. So we are active in each. We are a very large allocator to funds through the different things that we do.

Secondaries remain an increasingly big part of what we do. And directs in that filtered way are also important. So probably not relevant to get into overly specific percentages, but each are very meaningful parts of our business.

Siddhartha Ahluwalia 31:25

And what’s been your micro VC strategy? Would love to know that.

Hunter Somerville 31:30

Specific to how we invest in the seed category, we define micro as sub 300 million. So it’s a broader definition than I would say others that maybe would say that it’s 50 to 150. The reason for that is we’ve been investing in this category for a long period of time.

And many of our best performers have evolved, added team members, and have participated more meaningfully in follow-ons over time. And so we have wanted the latitude to be able to continue to support them and be more flexible in terms of how we define the fund size piece. That being said, the entry point has to be some type of seed or small series A.

Siddhartha Ahluwalia 32:15

And it’s interesting to know, right, at least from an Indian vantage point of view, that the funds that you banked initially in India, Nexus, Lightspeed, Charate, now they’re all evolved from, you know, let’s say 200, 300 million to more than 600 million.

Hunter Somerville 32:32

Groups have gotten bigger, yes, that we’ve originally backed in India. That is why we have begun reflecting as well on who we can add on the smaller end. And I think that corresponds with how India has evolved itself and how the market opportunity has gotten bigger.

So the groups that have decided to get bigger, I think remain interesting in their own right. But we’d love to complement those groups as well with folks on the smaller end.

Siddhartha Ahluwalia 33:02

And has it happened that, you know, there is increased interest from your LPs also in India over the last few years because of China getting blocked?

Hunter Somerville 33:14

Yes. I think there is increased interest in India and in Southeast Asia and in South Korea, specifically as people think of other ways to get exposure in Asia. India seems to be the furthest along, although I think South Korea is very interesting as an ecosystem separately. Southeast Asia is still earlier on its journey and has not actually, in my opinion, shown as much from a realization DPI standpoint.

I think that will improve. And so we’re actively thinking about that region as well. But India is the furthest along on that journey from our perspective.

Siddhartha Ahluwalia 33:54

So now I want to ask a specific question, right? For all the emerging managers from India and these emerging regions listening to the podcast right now, what has been the process for a new fund manager recently to get a check from StepStone?

Hunter Somerville 34:10

So it’s all about relationship building early on. You know, while we have not done a lot in the 25 to 100 million level or really anything at all specific to India, it doesn’t mean we’re not open to beginning to build those relationships. And there may be someone that really inspires us to take the leap.

We’re not opposed to it. And so what I would say is it’s good to begin to get in touch with us, build relationships. We then get that pattern recognition that I described up front that’s super important to what we do and see you in action, see the follow on rounds that occur at the portfolio company level, see the TVPI appreciation, what causes that, what leads to that, see the evolution in terms of ownership percentages, which we really do care about with anyone that we work with on the micro side.

We don’t want people who are a clubby deal participant who come in with two to three percent ownership. We want someone that’s leading seed rounds or leading series A rounds getting 10 to 20 percent ownership and is seen as that go-to partner, at least in that stage, because we want that to lead to scenarios where, the entrepreneur and founder is coming back in a repeat way to work with those same groups at each stage on the journey.

We’re not as much of a believer in lottery ticket approaches to seed investing, and we don’t think that it’s enduring. And you can’t always do that up front when you’re operating out of a $25 million fund. You’ve got to get into the best companies and still add value and create a brand and reputation.

But inevitably, you’re going to get better at that if your interests are similar to what we’re looking for, which is to become more of that go-to partner at whatever stage you’re the most comfortable with.

So all of these are things that we get to know, that we look for, we track as we begin those relationships. And so we’re not going to make a commitment like immediately with someone we don’t know.

It’s going to be more of that relationship building, that tracking, and then seeing, like, from an integrity and partnership standpoint that this is a group that mirrors what we care about in terms of grit and work ethic and collaboration and intensity.

And people can put off a good vibe on that on one phone call, and you’re not going to get to know that until you break bread with them, you have lunch, you spend time with them, you get them sort of off the cuff and see it in action. That part really matters to us too. A lot of people are good at giving lip service versus following through.

Siddhartha Ahluwalia 37:00

And let’s say to back a new manager in 2024, how many managers would you see?

Hunter Somerville 37:08

I mean, that’s hard to answer because we invest in a lot of different ways. But we will add new managers in 2024, for sure, and are open to it at all different stages from micro to late stage. We are always adding new managers.

It’s just about deciding who are the best groups in each of those categories and what we’re looking for. And by geography, it will be the same. You know, we are actively scanning the Indian market.

We added a handful last year, we’ll continue to do a bunch of managers this year, but we’ll be selective about it. It’s not like we’re going to suddenly start adding a ton of new ones and it’ll be, you know, two or three over the coming years to complement the ones that we have that we’re very happy with. And we’ll be selective about that.

Siddhartha Ahluwalia 38:04

And in India, the directs that you have done till now, Zepto, PocketFM, both have been on the consumer side. Are you also excited by the cross-border SaaS that has recently come out of India, Freshworks, Postman and a bunch of other companies?

Hunter Somerville 38:20

Very much so, yes. We do a lot in SaaS investing and would love to do more in that category. But you’ve got to balance that with some of the pricing dynamics that we’ve seen because with where we’re entering into most of these companies, which would be more like B, C and D, for a while, the pricing was just divorced from reality, in our opinion, and we’re not going to follow suit with that just because that’s the crowd and herd mentality.

There is probably a better time for us to consider doing things, but still, it depends what last round pricing looks like. And a lot of companies aren’t growing at the rates that they were before, so growing above last round pricing can increasingly be difficult. But certainly very interested in that category.

In many ways, that actually fits our model better than consumer, although big fans of the two companies that you mentioned, and glad that we are investors there. But, you know, we are more suited to do cross-border SaaS.

Siddhartha Ahluwalia 39:22

And why is that? Why does the preference for cross-border SaaS come then, where you can invest in a similar sector, similar category, which is built from US, selling in the US?

Hunter Somerville 39:34

Because we just have more comfort with enterprise investing, I would say, and more history in doing that in the US, at least. That is where we are more active. I think consumer has more binary potential to its return profile, and when we do direct investing, it’s still venture, so we’re going to have losses.

We’re not going to get it right every time, but you have the increased comfort of recurring revenue, and there are metrics that are very clearly important to track from an upsell, cross-sell, churn standpoint that we’re very comfortable with and very used to. And I think we are increasingly going to do more on the cross-border side than we’ve done, because we’ve done a lot of domestic SaaS investing over our history and are very comfortable in that area.

Siddhartha Ahluwalia 40:27

And what’s been your history of exits in India till now?

Hunter Somerville 40:33

I mean, the direct side of what we’ve done is all very recent, so it would be more on the fund side that I’d have to answer that on. For a while, like I said, we were sitting there with good TVPI and DPI that we were wondering, is this ever going across 1x? And now when I look at the metrics of a lot of our managers, I’m increasingly impressed with how much progress has been made in that regard, and even with the older funds.

And the older funds have different exposures in them. You know, if you really rewind back to what many of the Indian managers were doing 10-ish years ago, it’s a different dynamic than where they’re investing now with the increase in cross-border SaaS and other categories. And so some of those are much less traditionally venture categories or fringy venture categories.

Even there, what you’re seeing is the utilization of secondary to wrap up those pools of capital and to sell that to private equity or to secondary players. And so we’ve seen a marked improvement in terms of capital being returned.

Siddhartha Ahluwalia 41:42

And tell us about any secondaries that you have done in India and funds till now.

Hunter Somerville 41:48

We have bought LP interest purchases, where people have been fatigued by those situations that I just described, where they’re getting into higher years and they don’t want to continue to wait and they’d like to redeploy that capital, where we’ve come in and we’ve bought from specific LPs in that regard.

We’ve looked at and are considering actively right now a number of direct secondaries, where we would buy from employees within companies or where we would buy from older seed investors once a business gets to a very advanced growth stage and a shorter duration for us at point of entry. And we have had a handful of the continuation fund discussions, but I’d say that is still early.

We would like to see more of that from the region. And so happy to have discussions with people that want to think through that or want to see what we’ve done in other regions, because we’re very active in that category. But I would say, still, I’m not seeing a ton of that.

And I think it’s still early. A lot of people are talking about doing it right now. I think you need some marquee examples of that happening for people to really have the comfort level to move forward there.

Siddhartha Ahluwalia 43:08

And have you done secondaries in funds where you are not a first or a primary investor?

Hunter Somerville 43:15

Yeah, totally. That’s not a requirement for buying LP interests. There, what matters more is, do we know the companies in the fund? And can we reference them? Can we get comfortable with them? Have we looked at them?

So that is a completely asset-driven decision. We’re buying LP interest generally in years 7 to 10 of the life, I would say, if I had to average that out. So we’re not going to buy secondary interest when it’s like two to three years old.

That’s like almost a season primary and doesn’t fit our duration characteristics that we would be looking for. And so it has to be a little bit more advanced and mature in terms of where those have gotten to. But that is entirely driven by the assets, particularly because at that point in time, the GP can’t screw it up either way.

There’s not really much left to decide on. Reserves have been mostly deployed. The GP itself doesn’t matter as much.

Siddhartha Ahluwalia 44:20

Understood. And one of the things that you mentioned earlier in the conversation is the US is becoming more and more difficult to IPO even at 500, 600 million top line. Why is that?

Hunter Somerville 44:32

Yeah, hopefully it’s not going to 500, 600. But I have heard people say that. To me, it feels like the requirement is more like 200 to 300.

But the public market in the US is demanding more scale. I don’t know if that’s a risk consideration. I don’t know if that’s more regulatory driven.

I think probably components of both. And just the micro cap segment in tech, I think people are increasingly interested in waiting for businesses to be further along in scale. And so that’s positive and negative for what we do.

From a secondary standpoint, that gives you more bites of the apple a long time because these companies are going to be private for 10 to 12 years instead of like eight. And increasingly, people within the cap table are going to get tired or need liquidity options for other things that they’re doing. As an investor in seed and series A funds, that becomes more of an issue and more problematic.

And that’s why I am constantly preaching for managers to be more opportunistic and thoughtful about selling into growth rounds, particularly if you’re a seed investor that’s been in a company from the very beginning.

And no one wanted to consider that in a high momentum environment where everything just kept going up. And everyone who didn’t do it is now sitting there regretting that they didn’t sell 20 to 30% of their position and actually put some DPI points on the board.

And for the folks that opportunistically did do that, they probably got a price that is higher than what the rest of their portion may even end up at. And so it is good, prudent portfolio management. And people who come in very early in an increasingly elongated asset class need to be more thoughtful about doing it.

Siddhartha Ahluwalia 46:30

And tell us more about the LPs that StepStone raises the fund from.

Hunter Somerville 46:36

Diversified in every way. So we work with all types of LPs from high net worths to sovereign wealth funds, pension funds, endowments across the board. So it’s very broad.

It’s very diversified. And it’s all different types of sizing too. We want to, in our view, democratize access to the asset class.

We don’t think it should just be reserved for certain profile types. It’s an area that should be important and accessible for every type of investor that’s out there. And so we bring no snobbery to bear on who we would like to work with.

It’s all about the people and what kind of partnerships we can build. And hopefully that we can be additive in ways even beyond having them as an investor as they think about their broader venture and growth portfolios. It’s also very well diversified by geography.

I think we’ve always been more thoughtful about talking to people in all different places and increasingly offer them access to different markets on the venture side. So very, very thoughtful about how we’ve built that over time, how we continue to build that and think about how we can be a really additive partner, like I said, beyond having them just invested in something we do.

 

Siddhartha Ahluwalia 47:58

And though you have touched it upon a little what are the most important questions that you ask emerging managers?

Hunter Somerville 48:06

Yeah, I mean, it’s less about like some sort of gotcha question or some like overly interesting academic question. I think so much of it comes down to psychology and just interpersonal interaction. You really get to alignment and drive through spending time with people in person.

And we always have a bias towards probably the hardest workers out there. We like people with more of a blue collar mentality that have had to earn something in life that have dealt with difficulty. And I think you realize the importance of that in a sideways market.

People that feel like this is like a clubby thing instead of a job, I think have been reminded that’s not the case. This isn’t easy. It shouldn’t be easy. You’re investing in companies at the very beginning.

A lot is not going to work out. You’re going to have difficult conversations all of the time. Founders are going through emotional distress with the ups and the downs. You have to be a good partner. You have to be a good listener and communicator there. All of this should be hard.

So the managers that are the best are the ones that understand that, that aren’t going off the rails and becoming overly emotional as they’re talking to their founders or talking to their LPs. So we want battle-tested individuals, people that have undergone diversity, people that continue to work hard and give 110 percent, people that don’t view this as a club or a way to get money to invest instead of doing it themselves. Situations where there’s really good alignment and where what they do matters to them.

And it doesn’t have to all be in terms of GP contribution, but just in terms of passion. You can see that in people’s faces, that they love what they do and that they’re doing it the right way, and that this isn’t just to try to crank out millions of dollars at the end of day and be able to buy a boat or a fifth house. You can tell the difference if you truly spend time with people and get at their core and get at their motivation.

Beyond that, you have to be good at building teams. You have to be good at hiring, finding talent, finding talent gaps that you don’t have. And not bringing too much of an ego, but bringing enough of one where you have that chip on your shoulder where you want to build a great brand, but where it doesn’t erode on your ability to have great team chemistry and great team dynamics, and where no one wants to work with you because you’re intolerable in some kind of way.

And so all that psychology, interpersonal dynamics as well. Once you get through all that, you feel like you’ve got a right team or a right person, then it gets into the companies and what you’ve actually done body of work, where it’s ownership percentages, it’s reserve decisions, it’s where you’ve built concentrated positions over time. It’s understanding those companies.

And then the step after that is understanding if the founders actually think that giving you that equity was warranted, and if that would lead to a repeat relationship or like a very special reference, because that then builds the brand equity and the referrals and them sending people your way or coming back and working with you again.

And so that’s what you see over time. It’s not like one great question where I’m going to try to get you to stumble on something. It’s like, I’m going to try to get to understand you like a human being. And like if I was sitting at a three-hour dinner with a friend and trying to understand what motivates them and what drives them, that’s the process.

It’s not like a great 20 question RFP that I’m trying to sound more academic or smarter than someone else on. I wouldn’t want to build a relationship with that anyway. Like when we have to answer those, like, you know, we’ll do it. We have a team that can fill it out.

We’ve probably seen near every question that can be listed. It doesn’t bring me as much joy as when someone is actually talking to me and trying to get to know me and understand how I tick. Then I increasingly have a deeper respect for the person on the other side.

And those normally lead to more productive relationships from both sides.

Siddhartha Ahluwalia 52:36

And this is a very important question that I want to ask because you have been in this industry for such a long period of time and working with 200 managers. What are the few traits that you have seen in some of your best managers or let’s say the top five percentile of your managers?

Hunter Somerville 52:50

Yeah, I think it’s what I just described, honestly. It’s grit. We have everyone read books about grit that we’ve given to our team.

And similarly, that’s what we would want from people we work with. Mastery, I think, is another characteristic we like. Just people that love their craft and always think about ways that they could be doing it better.

And then people that are receptive to feedback and are looking for that. There’s nothing worse than a fund one or two know-it-all, particularly some of the spin outs where they’ve left and they feel like they have nothing left to learn. And we’re probably not the right partner for that because we’re just not going to passively sit and listen to a webinar update and see you every two to three years.

So maybe you’ll be successful, but maybe you’re not the right fit for working with us. And so those are important characteristics. And then I’d say someone that can really motivate and connect with a team because increasingly you’re going to have to have junior resources or people that you work with.

And these are 10, 20 year, 30 year kinds of relationships that you’re going to have to have. One of my partners, I’ve known since I was six when we were playing little league baseball and we fight and bicker like a married couple all of the time. Our wives are our good friends and they make fun of us because they act like we are sometimes married.

So John and I have known each other that long and we can have fights and we can yell at each other and in 24 hours it’s over and we’ve moved on. For other people that don’t have that depth of relationship or haven’t tried to build it, those fights can fester and you don’t bounce back from it and it creates resentment or someone feels like they’re better than someone else at key parts of the business and that doesn’t go away if you don’t have that fundamental core trust from a relationship standpoint. So we’ve seen too many firms break up because of very simple relationship dynamics.

Siddhartha Ahluwalia 55:10

And this is a very important question that I’m going to ask you. A lot of fund managers started in their late 40s in 2005 to between 2010 period, for example. I’m mostly talking about from a historical point of view, India, let’s say even A16Z in the US and the likes.

And now these fund managers are nearing their 60s. So do you see, you know, the relationships that you have built over the last 15 years, succession planning has not happened because now the junior partners are leaving and starting their own funds?

Hunter Somerville 55:48

It’s an interesting question. I mean, I think succession planning is extremely difficult to do in venture and a lot of people fail at it and don’t approach it the right way. And I think there’s master classes that people could be put on, but a lot of people won’t talk about it.

Right now what I’m seeing is probably more of like a festering kind of situation because it’s pretty difficult to spin out and start your own firm right now. You know, people who may want to do that are just going to choose to wait because LPs aren’t adding a lot of new managers. They’re not focused on that or they don’t have the capital to be able to do that.

And they’re re-upping with their existing managers. And in many cases, they’re re-upping at lower levels and they don’t have that kind of flexibility to add a bunch of new groups. And so for the people that feel like generational transition has not gone well, they’re not actually leaving and they’re staying.

And while they’re staying, they’re not getting what they think is their due in economics. And they’re carrying maybe even some boards from older partners that have pushed them off and want someone else to cover them. And those are the ones that aren’t working as well and that take up a lot of time and emotion.

Some can be as rewarding, but they’re emotionally turbulent to some degree. And so I think there’s a bunch of organizations where you’d have that dynamic with the younger partners feeling overstressed and sort of captive.

And I think what everyone just needs to be honest with in their organization is finding a way to have the economics shared in the right way and to allow younger people to be able to find new deals to do in a great innovation cycle while still helping from a board coverage and capacity standpoint.

And for people whose hearts are no longer in it, they need to think about evolving their roles. I don’t think it’s an age thing. It’s like a motivation and passion thing.

There are plenty of GPs that are still super passionate and active in their 60s and 70s that have lots of lessons to teach. But if you’re one of those that have gotten into your 60s and your heart’s not in it anymore, and it’s purely an economics game, you’re not doing anyone a service by that. You’re not doing your LPs a service by that, and you’re not doing your fellow partners a service by that.

And it’s incumbent on you to allow them to develop the relationships with your LPs and be seen as that go-to, go-forward partner. That’s the other issue. In many of these scenarios, the junior partners don’t have enough interaction or connection with the LPs because they don’t do the fundraising exercises or the fundraising calls.

And so if the senior partner leaves, then the LPs get spooked, and you potentially bring risk that way. So yeah, I’d love to see more senior partners, particularly those that aren’t as passionate as they used to be, think about ways that they can really empower and make some of their younger partners happy so they don’t have to deal with spin-outs and mass attrition. Because at some point, when it becomes easier to raise, all these people that have been doing this aren’t going to stay.

Siddhartha Ahluwalia 59:10

And what would be your advice to a fund like NEON, let’s say trying to raise between 50 to 100 mil from institutional LPs in the US?

Hunter Somerville 59:22

Build relationships with some of the thought leaders on the LP side, be additive, be helpful, be informative, don’t be annoying, send updates that are relevant, not just pinging people with nothing to say.

Find a way to put together a good format on how your portfolio is doing, a good email blast with really interesting company and firm-related information, or do periodic quarterly or semi-annual webinars where you go through it and where people can just digest it.

Sometimes that’s actually more helpful than needing to do a 30-minute call with someone to tell them very little new news, or it puts too much pressure on the LP to really give an opinion quickly, where you could actually just have them see through the email summaries or the webinars that in more of a passive way.

And try to be helpful beyond asking for their money. Give them a macro point of view on the region or the category. Tell them about interesting stuff going on. Make introductions to other people that could help them get comfortable with things from a macro standpoint.

And think about it more as how you’d build a relationship with someone than how you’d be just asking them for money is what I would say.

Siddhartha Ahluwalia 1:00:50

And there is a very important question that you asked. Investing in relationships for a long period of time before you see any fruits out of it.

Hunter Somerville 1:01:00

Yeah, I mean, that’s venture. But for the people that really know venture, they’ll see the progress in the firm, the firm development, the people, the brand, the portfolio companies themselves. And, you know, nothing that I can foresee in the near to medium term is going to improve the duration aspects of it.

But you know, hopefully end of day, you’re compensated with the multiple and the alpha that you get from this category, at least for the people that do it right.

Siddhartha Ahluwalia 1:01:30

Thank you so much, Hunter. It’s been a very insightful conversation with you. I hope you enjoyed it as much as I do. And our listeners.

Hunter Somerville 1:01:36

Yeah, this is great. Yeah, no, thanks for thanks for having me and a great conversation. Really appreciate it.

Siddhartha Ahluwalia 1:01:44

Thank you. Thank you so much.