Association Series #7: David Moss, Investor @ SecondQuarter Ventures
Uncovering how interesting minds entered Venture Capital and new aspects of their personality, experiences and processes to light.
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#7: David Moss, Investor @ SecondQuarter Ventures
1/5 Career overview before joining the Venture Capital fund, SecondQuarter Ventures
I just wanted to say that there are many steps people can take to shape their career arc. But often it comes down to little more than luck and timing.
My journey into venture capital is certainly an example of this.
While at university, I spent some time working for a small startup that was building a peer-to-peer payments app - something similar to Venmo in the United States. However, that venture ultimately didn't work out.
I decided to start looking for graduate roles in investment banking, but was rejected by every single bank during the application process.
By pure serendipity, just as the graduate applications had closed and everyone had been hired into all available positions, one of the analysts at Moelis resigned. They began a very limited search to fill that role. When I look back, I honestly think a “limited search” was probably the only context in which I could have been successful.
And so I ended up getting a job in banking at Moelis in the technology sector coverage stream. I stayed there for almost five years, slightly longer than most, but the timing ended up being perfect.
Because the moment I decided to leave Moelis was the time SecondQuarter was making their first hire. So, I ended up joining as a member of their investment team in 2021.
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2/5 What was the interview process to join SecondQuarter Ventures?
Stage 1 - The first stage is a blind application process, involving five short response questions which are anonymised and graded by the entire team. I enjoy this type of process as it's designed to remove any bias from the initial candidate screening.
Stage 2 - After the initial process, I had a Zoom meeting with the managing partner and a member of our investment committee. This mostly involved behavioural-related questions, but they also tested the way I think about investing in technology businesses. They asked me to discuss some examples of companies I might invest in and gauged my overall interest in the Australian venture landscape.
Stage 3 - The next stage was a case study.They provided us with the framework that SecondQuarter uses to assess every new investment. They gave us a company with some limited publicly available information and we were instructed to complete this framework, explaining whether or not we would invest and why. There was also a brief financial modelling component in this process, and a follow-up meeting to explain the ultimate recommendation we reached.
Stage 4 - After that, there was a Zoom call with our chairman, serving as the last screening process, and then a final meeting with the managing partner before I secured the job.
The benefit of interviewing with a small team is you have the opportunity to meet everyone, often more than once, in a very short timeframe.
SecondQuarter’s Framework
In terms of the framework potential candidates complete, it is a structure for building an investment thesis that assesses a company based on several dimensions including the attractiveness of valuation, competitive advantage, degree of product-market fit, the founders, and so on.
As a secondaries fund, one additional consideration that comes into our process is an assessment of the degree to which we have enough flexibility to provide secondaries to the company in the future..
It asked us to consider any senior ranking shares, or terms of the existing shareholders agreement that might restrict us from being able to fulfil our role as a liquidity provider.
3/5 Looking back on the past 12 months of being an investor, what two skills have you found most valuable?
To go with a slightly less conventional answer, I’d say a trait that served me well so far is skepticism. The venture community is often perceived as being almost deterministic in its optimism. However, to me, optimism is just table stakes to a career in venture capital.
If you didn't believe that the future would be better than today, and that technology would play a fundamental role in shaping that future, then I don't think you'd truly consider venture in the first place.
That brings me back to why skepticism is important. As a junior investor, you meet a lot of new companies. You are presented with a lot of numbers and forced to quickly up-skill in new markets.
Sometimes, you walk away from a first meeting completely blown away by how well a founder can articulate their vision of the future. It can be difficult to not be swept up in their optimism and passion, or be blinded by the opportunity for growth.
So it is really difficult to distil the signal through the noise. I think a healthy level of skepticism can help cut through some of that noise and focus on what a good process can reveal.
The second trait I'm going to suggest is particularly useful is humility. Sometimes, we can be successful in an investment for the wrong reasons. Looking back on past decisions that went right, it's difficult to dissect an outcome in a way that dissociates luck from skill.
You have to recognise that investing is a probabilistic endeavour in which the chances of success can be improved with good process (or hoping for a lot of luck). Rather than focusing on the outcome, being humble about success in investing allows you to focus on improving the processes that lead to good decision making.
Another thing to add is that success in venture capital is measured over long periods of time. For many young investors like me, it's tempting to view things like an up-round in a portfolio company as success - because that is likely to be our first experience of it. But success can only really be measured by the capital returned to investors, which takes a really long time. Humility helps stay focused on the long-term outcomes that matter most.
🔒 Below is a bonus section.
Unpacking what it means to be a “secondaries” investor and how they operate including specifics on the what, when and how.
4/5 (a) Can you explain your unique approach as a secondary investor, especially considering that you interact mainly with “vendors” rather than founders or companies directly?
I think the primary reason our approach differs is because the capital we invest does not go to the company; it goes to the vendors.
But even though we are technically transacting with the vendor, everything we do is facilitated through the company and its founders. So very frequently, when we are contacted by an employee or early investor, we will reorient the focus of those conversations towards the founders as the basis for our due diligence.
Our due diligence process also differs slightly from other investors. Since we are not providing capital for the company's growth, it can sometimes be difficult to convince a founder to dedicate as much time to a secondary process as they would in a traditional primary round, particularly when they're not the ones selling.
For that reason, a fundamental part of our investment process is to understand the business, its industry, and its competitors as quickly as possible, while limiting the amount of time we take from founders.
We describe this as a sort of “remote” due diligence process. After the first meeting, we often step back and leverage various expert networks, tools like PitchBook, and other resources.
We often conduct a lot of third-party and external research and reference checking before we even come back to the founder with our initial response.
A significant part of the work we do is to respect the founders' time in a way that I believe other investors may not necessarily be forced to prioritise.
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4/5 (b) Are there any other considerations unique to secondary investing?
One difference in secondaries is that we are not being issued new shares, but rather purchasing existing ones.
Commonly this means we are buying ordinary shares in a cap table that is comprised of many different instruments, including various classes of preference equity and/or debt. So the ranking of the equity we are purchasing relative to the rest of these instruments factors into our investment framework and ultimately affects how we think about pricing.
This is why secondaries often transact at discounts, which is a lesser known component of the secondary market. Many employees or early investors often benchmark their views on valuation based on the price of recently issued preference shares. But those come with special rights and protections that often don't exist in lower ranking ordinary shares.
We believe there's value attributable to those special rights, and discounts are one tool to help account for the risk associated with the instrument we are purchasing.
4/5 (c) Could you explain how you manage pricing and liquidity in the context of the Australian venture capital market?
We not only provide liquidity to companies and their shareholders, but also to VC funds and their LPs (Limited Partners, the investors that provide capital to VC’s).
To date, much of the liquidity interest from VCs has not been GP-led - that is, not led at the general partner level - but rather by the investors (LPs). Essentially, these high net worth individuals or institutions that have been invested in these funds for an extended period of time.
Often they have already enjoyed meaningful investment gains, but there has not been an opportunity to realise this upside through distributions. So liquidity becomes a useful way for them to generate distributions and realise a portion of their investment returns.
Australia’s venture ecosystem is still young. But as some funds are approaching their 10 year term, we have definitely seen increased interest from general partners looking to provide liquidity on either individual assets or a portfolio of companies.
This is a natural part of the process of recycling capital in the venture ecosystem, allowing venture funds to return capital to their LPs in order to raise new funds and invest in the next generation of great technology businesses.
We believe that secondary offerings will play a crucial role in this.
5/5 When is the right time hypothetically for startups to think about secondaries and where do they start?
Yeah, so there’s a couple of ways to answer this question.
I'll start by describing the way we see secondaries and how we view one of the purposes of our capital – and that is to align the time horizons of different stakeholders throughout a company’s private market journey.
No two private market journeys are the same, and shareholders' needs often evolve as the company matures. Sometimes founders need liquidity for personal reasons. Sometimes they want to reward their employees by using secondaries to help them realise some of the value they've helped to create.Alternatively, they might have VC shareholders who need to recycle some capital to provide liquidity to their investors.
So I think the optimal timing for secondaries will be determined by these stakeholders and their respective needs for liquidity.
We have provided liquidity to founders who have used the funds to pay off their mortgages, purchase a home, and finance their children's education. So sometimes personal circumstances will also dictate the right time to think about secondaries. I would argue that alleviating these types of financial stresses positively impacts their decision-making and ability to take the long-term risks necessary for outsized value creation.
That is why we see founder liquidity as a key feature of a healthy venture ecosystem.
The second way to approach the question is by describing the types of businesses that meet our usual investment criteria.
These businesses are in their growth stage, and can demonstrate evidence of product-market fit with a well-established business model. Often these businesses have already raised at least one round of capital from a VC fund.
In terms of size, we typically look at companies with a valuation of at least $75 million, although there are certainly exceptions to this rule.
5/5 (a) You mentioned vendors, who are the vendors and how do they work?
Vendors can be anyone who is an existing shareholder.
Founders and employees are two very common vendor archetypes. The reason liquidity has been popular with these groups is because it helps to reinforce a clear attribution loop - you've worked hard to create value for the company and secondaries are an opportunity to realise some of it along the way.
There has also been a growing interest from VCs who have funds reaching maturity and are looking to generate liquidity for their LPs.
5/5 (b) How does it work?
Typically, when a secondary process begins, there will be various pre-emption rights in shareholders' agreements.
There are always going to be instances where we aren’t able to transact as easily as we’d like because of restrictions in a company’s shareholders agreement. But once we are invested, we have secondaries friendly clauses that companies can use to more easily facilitate small amounts of liquidity for their shareholders along the way.
As far as how this works, once we have made the decision to invest, the founder will reach out to long-term shareholders and employees who are interested in liquidity. They'll often group these together in a single secondary transaction.We buy shares directly from these vendors and they receive the cash directly.
5/5 (c) What advice would you have for founders about secondaries in down markets?
One feature of the market in recent years, is the use of secondaries by large global funds in order to reach their minimum investment amounts.
When the primary requirement of the company doesn't meet a funds minimum investment amount, they sometimes utilise secondaries to achieve that minimum. This has become more prominent as fund sizes become larger.
Often, these funds require the vendors' shares they're purchasing to convert into preference shares. While this can maximise the value realised by vendors in that round since those preferences are always more valuable than their existing common shares,
I would caution that the ultimate effect of this approach is to add to the top of the preference stack. And preference shares are, in effect, a kind of liability for the company.
Meanwhile, many of the founders and employees usually hold only common equity.
When funding environments are easy to navigate, and valuations seem like they are always increasing, it's tempting to assume that this will never be a problem. However, adding to your preference stack ultimately creates additional risk to all of the instruments that rank beneath it, something which is becoming more important in adverse funding environments.
Today, it is not uncommon to see companies doing flat rounds or even down rounds., So when they raise their next round, it creates an even bigger preference stack relative to the size of the business.
Therefore, it's crucial to understand how adding more preference shares might create more risk for common equity holders.
Thanks for reading this instalment of the Association Series! Get in touch with me anytime here — to share your thoughts, suggest other questions and/or people we should feature.
Fly high,
Vidit, Alfie and the Curiosity Center team