E131: Can VCs Make Money in Deep Tech? w/Nick Shekerdemian

So I think that's a very interesting and quite terrifying biodefense problem that I've been thinking a little bit about with some of our companies recently, which is if cyber was like the recent iteration of like the kind of quote unquote fashionable way of attacking adversaries, and maybe more traditionally that was actual physical weapons, I think the next iteration of that is probably using bioweapons. And I think that the way that plays out is using AI.

I think AI's ability to create new protein structures that can evade traditional vaccine is really powerful and a little bit scary. There's a very, very linear correlation between reporting cadence and performance of the company.
As companies tend to go downhill, reporting tends to get sloppier. It isn't as extensive.
It isn't as frequent. We can generally tell.
We've seen enough companies now to tell from those signals. You mentioned founder breakups.
It's arguably the number one issue for seed stage startups that fail. How does a company go about navigating a founder breakup? You decided to drop out at the age of 20 from Oxford after getting accepted into Peter Thiel's fellowship.
Tell me about that decision. Yeah, my family didn't have like a history of going to Oxford every generation.
And so it was a pretty kind of meaningful decision for me. But at the same time, it was a supernatural decision, not least because the Thiel Fellowship has obviously got an incredible reputation.
But I think kind of more importantly, you know, I was at the right time for that decision. And it's definitely been among the most impactful decisions, if not top two or three most impactful decisions of my life to do.
There's only been a couple hundred Teal Fellows and already some incredible breakouts like Ethereum, OyoRoom, ScaleAI, Polkadot, to name a few. What do you attribute to the success of the Teal Fellowship? Why is there such a high hit rate? It's a maybe a mindset or mentality of the kind of person who has not only taken the initiative to build a company during college, but also and to do so, you know, with some traction or some kind of early success.
But to kind of have the, I guess, the internal drive to drop out and pursue this full time against all of the social pressures and all of the social norms. I think that takes a certain kind of attribute in terms of personality.
And I think that combined with, frankly, the Teal Foundation and Teal Fellowship's ability to find those people and bring them together i think that combination is is is pretty unique and i think the fact that it hasn't scaled in some ways is is the is the feature it's by design and i think it very much contributes to such a high hit rate of success i think that the um you know the the kind of more formulaic programs that are more scaled ultimately will have a higher number of unicorns on a number basis or a higher number of successful outcomes on a number basis. But the percentage hit rate likely won't be as high, even though you have more shots on goal.
I think there's a couple of factors there. One is the Teal Fellows are figuratively burning the boats.
They're dropping out of college in order to pursue something. So they're all in and that kind of focus.
I think the second one is obviously, you know, it's it's picked from 10s of 1000s of applicants. And, you know, these are like the elite, the most most elite, the highest IQ people.
And then of course, I think the Teal Fellowship itself has become a sort of signal or a self fulfilling prophecy. Once you're in the Teal Fellowship, you're able to raise a lot of capital.
And then that obviously significantly increases the chances of success. Yeah, I definitely think there is some self-fulfilling kind of attributes to it, the same as you have with any kind of like elite community or some sort of, you know, high profile kind of, you know, community or in many other cases, awards and things like that.
I definitely think that contributes to it. And I think as the fellowship evolves, the concept of dropping out of university to start a company is still rare, but not as rare.
But I think that you'll see a complete kind of refocus on big ideas, which I think is critically important. You mentioned portfolio construction, you have strong, strong views on portfolio construction for seed stage.
What are your views on how portfolio should be constructed? I guess why we've chosen to think about things the way we have at TBC. You know, our view is that with a slightly larger team than your average seed fund at eight people, we have an ability to work with founders in a more proactive way than maybe you could do if you were two people.
And so that enables us to build strong relationships with our founders in an operating capacity that really gives us a few different advantages, but hopefully adds commensurate value back to the founders in what they're able to extract from that in terms of the kind of two-way trade or the two-way dialogue. And so for us, our advantage in doing that is something that leads to our ability to have a more concentrated portfolio construction, which is our kind of information asymmetry.
It's how can you make a kind of comprehensive decision in the rosiest picture of what a founder's story is going to be, which is your first investment decision. The first time you ever meet a founder, regardless of the context of the situation, it will ultimately be the most packaged and best picture of the business, which is ultimately the job of a good founder.
And so your first investment decision probably will, it may be your best, but it statistically is likely to be your worst from like a data to kind of information perspective. And so, you know, the ability to leverage a larger team to have an extended diligence process post-investment and then double down on winners is something we feel very, very strongly about.
And so our construction is relatively concentrated at the seed stage. We do about 30 companies every fund cycle.
The ownership at entry, which we can also talk about in a second for us, is 8% to 10% at entry, which is slightly lower than your conventional 20% of your leading rounds that you'd see in most funds. You mentioned that you have an informational advantage as an existing investor.
Tell me about that informational advantage. Yeah, I think this really comes down to your approach post-investment for portfolio success.
So I think you kind of really have three schools of thought there again, or three strategies there. Some highly diversified seed firms who have limited resources, but they want to get a large base of companies.
They probably aren't spending huge amounts of time working with their companies day in, day out. There's just a resource constraint in being able to do so.

And so I think that limits your ability to have information and thereby likely means that you should be spending the bulk of your dollars in your initial investment and trying to optimize for the lowest possible price. I think that's kind of got to be the strategy there.
I think the other end of that is a kind of a multi-stage firm who is using seed stage as a kind of an option on supporting companies. Whether they take a board seat or not is kind of bifurcating there.
But let's say they do take a board seat, the relationship tends to be relatively governance heavy. It's like I come to my board meeting, I'd like to understand what's going on and I'd like to help you make a couple of key decisions.
And that's like that's quite high level and quite specific to some very, very key decisions. If they choose not to take a board seat, they probably have that same lack of informational advantage because they're really ultimately waiting for a larger round and using their initial investment to kind of get them in the door.
And then I think you have kind of a strategy in the middle, which is if you can come up with a mechanism to have more resources, you can have a slightly more concentrated portfolio, but you can spend significantly more time with those companies outside of board meetings.

And I really emphasize outside of board meetings because I think board meetings are kind of the default place where VCs interact with companies and founders.

But I think they are probably the worst place to get into the real kind of bones of what's going on at a company.

So essentially, it's really a two-way street. Your informational advantage comes from being involved with a company and helping.
And the company gets that as a value from you as an investor. Correct.
That's exactly how I view it. It has to be a two-way street.
It has to be organic. The information requests aren't something that a founder wants.
I've been on that side of the table. Every time I get asked for information, it distracts from me doing my core job.
But if I'm being asked for information as a mechanism for me to be able to, let's say, receive an introduction or something that is relevant and something that furthers my goals, that kind of two-way street means that I'm very, very willing to play ball and give that information because it's value added to me to have that engaged relationship. To play devil's advocate, how do you scale this value-added strategy? I think that's a super valid question.
I think it ultimately doesn't scale infinitely, e.g. if you continue to put the same amount of effort into every company on an evenly distributed basis, that becomes very challenging.
We as a firm, twice a year get together and we actually have all of our team blindly stack rank our portfolio companies on a series of different metrics that give us a sense of the time input to progress of the company and how they continuously are performing. If a company is stopping reporting, is being less communicative, is ultimately growing slower, and we don't think we're going to allocate significant follow-on dollars to that company, we do make a conscious decision to reduce the cadence and volume of people on our team that are working with that company.
That's not to say that we abandon them or don't pick up the phone, but ultimately, we are in the business of trying to work out which companies are going to succeed and allocating our resources accordingly. And thereby, we have to be conscious, despite having an eight-person team, as to how we do that.
The dirty secret of VC is that every VC has their favorites and they're less favorites and don't always spend an equal amount with every startup. That's ultimately the business model that venture capital firms have to be upfront about.
It is a game where some companies will ultimately return the vast majority of the capital and others will not. And I think as long as that's front and center, I think the expectation needs to be, if your company is struggling and you need our help, we will be there.
But ultimately, our proactivity is obviously going to go towards the companies that are progressing the best and the fastest and who are ultimately on that kind of two-way journey with us, who are playing the game that we are playing in terms of we need the communication, we need the consistency of reporting, etc. to be able to do that.
And I think there's a very, very linear correlation between reporting cadence and performance of a company. As companies tend to go downhill, reporting tends to get sloppier, it isn't as extensive, it isn't as frequent.
We can generally tell, we've seen enough companies now to tell from those signals. When we were last chatting, you mentioned that you tell every founder, text me with good news, text me with bad news.
How do you get founders to open up and text you with bad news? It's really nuanced, right? And you can't expect to see everything in real time. But I do really believe that the quality of your relationship with the founder and explicitly that not being in a board setting, I think is really important.
Like we really do invest the time to try and build that relationship. We do work with founders to set those micro goals that aren't the macro goal of the company, but what are the specific things you're trying to achieve in working back from your next financing round or for your next milestone.
And I think by being integrated into that flow, I think it's easier to see those things of course we get blindsided the same way as other people get blindsided it's not to say that we see everything but i think even if we see 50 more that's a significant difference for us in our ability to plan how to one allocate resources and to support those companies in advance i think making it clear early on that we can only help you if we find out before it's too late. For example, if you're having a really big problem with your co-founder and you would like to part ways with your co-founder, knowing that before you're getting into a legal dispute or before you're trying to figure out how to transition them out is critically important.
We can only help you if we know that in advance. I think it's just things like that, encouraging that behavior early on and being hugely transparent as well.
One thing I think VCs do quite badly in general is managing expectations and things like follow on, things like decision to do pro rata, all of those types of decisions by being super, super candid and transparent early on as to how we make decisions, why we generally don't do bridges, even if they seem like a great deal, unless our information tells us that it is a great deal, things like that. We don't do things just for signaling, which I think a lot of people do.
And I think being really transparent around that whole process and how we think about those things and our philosophy is really important. You mentioned founder breakups.
It's arguably the number one issue for seed stage startups that fail. How does a company go about navigating a founder breakup? Thank you for listening.
To join our community and to make sure you do not miss any future episodes, please click the follow button above to subscribe. It's a really challenging and nuanced situation in every case by case.
So I think it's hard to generalize. But what I would say is getting to the kind of core of the motivations on both sides and cutting through those emotions to what is the most productive thing for the vision of the company? Is it a vision divergence, right? So is it, I think the company should go in this direction, you believe the company should go in this direction, that's a very different situation to, we just can't get on and communicate anymore.
That's a communication breakdown. Or a secondary, should we be taking a secondary? There's all kinds of nuances to that.
I think it's getting to the nub of what is the problem? Is it we're in the wrong role? That often happens. The CEO and the CTO, there's a friction or chief scientific officer, there's some friction around who's in that role.
And there's obviously always some egos at play, you have to have a certain amount of ego to be a founder. And so I think it's really getting to the core of that.
And then working backwards from that, how do we solve that? Is it a complete breakup? Is it a moving role? Is it a change in equity or compensation that there's always some way to solve it? I think not moving to lawyers immediately and not moving to kind of a toxic situation immediately is really important. And I think having a mediator who is somewhat unbiased is really important for that.
There's a lot of funds in the market. How would you explain to the LP or allocator community, TVC source of alpha? It's a combination of a few different things.
I think it's hard to kind of point to just one thing. I would say the first thing, and I think very importantly is where we choose to focus.
I think there is an under-emphasis on thesis-driven investing in venture. I think over the years, venture has become relatively concentrated into a few different categories.
So white collar enterprise and B2B software, consumer internet, we've very proactively decided to be quite thematic and thesis oriented in how we choose to invest. And I think that is a source of alpha in itself.
I think staying close to what the roots of venture capital actually are, i.e. investing in ambitious people, building very innovative things.
I think that's really important. And I know that sounds quite trivial, but I do think we've kind of gotten into a cycle of an ability to make money by using existing technological progress and applying spend on marketing dollars or things like that to generate returns.
And I don't know if that necessarily is kind of the core of venture capital or what will sustain. And so for us, that is spending a lot of time forming points of view and working out where the right communities of both investors and founders are within categories that we think are interesting.
So for us, we think we're at a very, very interesting pivotal moment in the healthcare system right now around personalization data and the applications of AI and computational biology in reducing the risk of operating in the healthcare industry whilst increasing the return profile because you are driving better outcomes at lower costs for people. So I think that's really important.
And then we secondarily thematically believe, you know, on that point that the physical world around us is going to go through a bit more of kind of an industrial transformation or some sort of re-industrialized process where everything will both become more sustainable. And so I think there's a very important moment in time where things need to be efficient, cheap, low cost at the same time as being more sustainable, which we firmly believe that there is an opportunity in with computational biology and chemistry and AI.
You mentioned a couple of categories that

could be categorized as deep tech. And obviously there's a lot of opportunity there, but a lot of

it takes a lot of capital. How do you make sure that your portfolio math makes sense in order to invest in these deep tech startups? The capital intensity and also the time duration are probably the two biggest kind of risk factors or criticisms that people make in investing in deep tech.
And I certainly think that has been the case historically. I would say we can simulate a lot of things, especially things that are not too hardware heavy in advance.
So I think there is a huge advantage right now in the kind of intersection of computational power or applied AI with biology and chemistry specifically in those kind of physical world aspects of deep tech, and also to a certain extent within the healthcare system on the bio side as well. So I think that there is a multi-year trial and error R&D process in some ways that can get avoided through these abilities to simulate things at scale.
And I think that that will only get better and easier. And I do think that's like three to five years of the journey and quite a lot of expense and risk can be automated pretty significantly.
And you see that now also in the ability to simulate things that are capex heavy, which also take a lot of trial and error, which I think is really important. So I think that's the first thing.
I think you can compress those cycles significantly. And the second thing is the outcomes can just be bigger.
I think people always underwrote to the unicorn valuation, like the billion dollar kind of magic number. I think you will start to see many Decker unicorns beyond using deep tech or kind of more kind of transformative IP rich things, where they are kind of either winner takes all markets or oligopolies that can be close to kind of winner takes all markets, where you will see just transformatively bigger outcomes.
You've obviously already seen it in your SpaceX's, opening eyes, XAI's, etc. of the world.
And there will be a long tail of a lot more of those companies over the coming years. So I think you can make the math work by just underwriting to a bigger outcome.
But I also think that the dilution historically was heavy because less investors invested in those categories. I think as more and more investors start to invest in American dynamism and a lot of these things that intertwine with deep tech generally, just by nature of what they are, you will see that capital come in and thereby you will see less dilution.
Seeing a lot of excitement around defense tech. Do you think the time has come for defense tech to really make venture-like returns for investors? There is an enormous amount of government funding still that maybe in the last administration went pretty heavily to like climate tech and things like that.
I think you'll see a lot of that go into kind of the American dynamism, onshoring of critical things to the US. Some of that is defense.
Some of that is more kind of independence or self-sovereignty. But I think that you will see a huge amount more investment there subsidized and supported by government funding.
Absolutely. But I see a lot of investors who were very anti-investing in defense a few years ago to a certain extent anti-investing in deep tech generally now shifting their focus a little bit because it's become both more acceptable but also more subsidized and also more in the kind of forefront of people's perspectives and minds and obviously this incoming administration is all about self-sovereignty of the US and bringing things back to being produced here.
And so I think that that is going to have to come with a level of subsidization. Labor is just more expensive here.
But I think the applications of AI and robotics will reduce that cost significantly. And so will, I think, kind of start to equitize that a little bit.
I think you've seen a similar shift in sentiment on the LP side. If you're an LP side, if you're an LP today and you're trying to invest in venture and the large funds, you really can't avoid defense tax.
I think some of those policies have been changing really in real time. When we last spoke, you mentioned that most VCs are momentum investors, but TVC is not a momentum investor.
Unpack that comes down to um your ability to uh pick areas not based on what is hot right now but what could be hot in future i think that's um it's trivial uh in in in what it sounds like but but in reality it takes a lot of work forming points of view and not looking at what the market is doing, you know, and informing those points of views with a fundamental first principles approach is really kind of counterintuitive to what we've seen over the last 10 or 15 years in venture, where I think the real innovation happened for the last kind of decade or so of the internet era. A lot of that real innovation happened in the prior decade with the cloud or the new cloud and the app store and the move to mobile.
A lot of those things enabled significant convenience improvement for your average person's life, which generated a huge amount of momentum behind things that could capture parts of that value stack. I think the interesting thing about that is if we look at the most fundamental industries in the US and further afield, things like the production of what we eat, or the things that drive the manufacturing of all of the goods that we consume, a lot of these physical world things, and to a certain extent, healthcare, but more specifically, these physical world areas, a website or mobile app maybe improved people's businesses a few percent, or maybe even 10%.
But they didn't improve them hundreds of percent, like you saw in the kind of more of the white collar service industries, right? So for someone, you know, who was a farmer in a field, you know, the web era didn't, it didn't really impact them, whereas the computational biology era or the applied AI and robotics era where their jobs are getting much more high margin and they are able to kind of elevate themselves and use robots for the lower margin things or use new products to ensure that crops are protected or other things like that. that is a huge multi-hundred percent improvement on the efficiency of running their business.
And that, I think, drives real innovation. I think we're about to see that in the same way as in white-collar industries.
We saw that with websites and mobile apps and software platforms, et cetera. You mentioned computational biology.
What are the opportunities that you see in computational biology today? Both computational biology and chemistry are very interesting now that AI is getting so good at simulating things. Let's take the healthcare system to begin with.
We give someone a vaccination or we give someone a therapeutic by putting something that is foreign into the body and having it work its magic, quote unquote. I think that's not the future of medicine.
I think the future of medicine is getting the body to produce things it already does every day, but on demand with the right payload or the right dosage on demand, right? So I think our ability to interface with our core critical intelligence systems,

the brain's not the only intelligent organ in the body, our immune system and our ability to fight

foreign things and read and write what's coming into the body is not equally as intelligent,

but is extremely intelligent. And our ability to interface with that, and then apply AI to

personalize that, that is like an incredible move forwards and shift in our ability to do things. And it's a lot cheaper for the healthcare system.
So that will be, I think, very transformative. So that's kind of probably one example.
And then maybe more in the physical world, a lot of the kind of commoditized products that, you know, we consume every day right now that aren't sustainable, take surfactants, for example, surfactants are in every detergent, cosmetics products, sunscreen, food color, and everything around us. It's not sustainable, and it hasn't really been innovated on for a long time, but it's effectively, in the most simplistic terms, kind of like the binding agent that's there.
Redoing things like that with new methodologies computationally and ensuring that it is both low cost and cheaper, but also sustainable, that kind of stuff we're going to see day in, day out, not with a green premium, but at cost parity or lower than cost. And redoing the physical world around us with that overlay, I think is really, really interesting and will be hugely important for things like

preventing wildfires and hurricanes and things that happen right now, which are deadly and devastating for people. To borrow Peter Thiel question, what do you believe about venture capital that very few others believe? Gosh, that's a tough question.
I think whether very few others believe this, or maybe I'm packaging it slightly differently. I think very few people believe that the current state of venture capital is not really investing in innovation, but is instead investing in ideas that have already played out.
I think the kind of contrarian perspective that I will hammer home forever is that the rate of innovation is so rapid right now. And everything that we see and do is so significant in terms of the rate of change right now, that the things that we thought, things that maybe took 10 years to play out last cycle, I think are playing out in months and maybe years right now.
And so if you don't take a very, very thesis driven approach to figuring out what is going on in the world and where the opportunities are, I think you get left behind.

I think we're going to see the biggest shift in venture capital that we've seen, probably at least since I've been even thinking about the concept of venture capital. And probably even since I've been thinking about the concept of a company and building a company and entrepreneurship in the next few years, not because of a reallocation of capital by LPs and allocators, but based on just the

relevance of the things that people are focusing on and how rapidly that will shift. That's my

big kind of bet and thesis. What's an example of something that some people might think is going to

be five, 10 years away that you think may develop in 2025?

So I think that's a very interesting and quite terrifying biodefense problem that I've been thinking a little bit about with some of our companies recently, which is, I think if cyber was like the recent iteration of like the kind of quote unquote fashionable way of attacking adversaries, and maybe more traditionally, that was actual physical weapons. I think the next iteration of that is probably using bioweapons.
And I think that the way that plays out is using AI. I think AI's ability to create new protein structures that can evade traditional vaccines is really powerful and a little bit scary.
And I think that it will take a reframing of how we both build biodefense capabilities, but just generally how we build vaccines and therapeutics to this arming the body in a personalized way with what the body already does right now extremely effectively. That play out, I think, will happen very fast.
It's scary for the world, but I think enough smart people are starting to think about that, that I think that some of the smartest minds in the world who maybe are currently working on medicine may be working on biodefense pretty soon. And I think that's a pretty exciting thing if you're ahead of the curve, and a terrifying thing if you ignore it that is coming down the

pipe right now. What would you like our audience to know about you, about TVC or anything else you like to share? Anyone who's trying to solve a very, very big problem that's challenging to solve that wants a thought partner in doing so absolutely should come and talk to us.
We're not scared of big ideas. We're willing to take risks there.
The whole point of venture is taking risk. And for me, you know, I personally am very, very excited by things that, you know, are obvious big things that are around us that people think are so established and incumbent that no one should dare tackle them.
tackling those problems with a new perspective as to why that should be changed.

And with an approach that is very first principle, that's always exciting to me.

And I'm always down to have that conversation to think about how that can best be financed.

Nick, appreciate you jumping on. Look forward to seeing you down soon.

Absolutely.