E35: Ben Gallacher of Cannonball on "Value per Dollar Invested" and How it Predicts Fund Performance

Episode Summary

Executive Summary: Ben Gallagher, an LP at Cannonball Capital, discusses his journey from founder to family office investor, emphasizing the importance of staying open-minded in venture capital. He advocates for a collaborative checkwriter approach, favoring diversified portfolios and emerging managers who are close to operators. Key insights include the pitfalls of direct investing for family offices, the value of founder references in due diligence, and the need for GPs to focus on time allocation and operational support.

Main Topics: Transition from Direct Investing to Fund Investing (Priority: 5/5): Gallagher explains how his family office shifted from direct investments to exclusively investing in funds due to adverse selection and the advantages VCs have in networks and deal flow. Spin-Outs in Venture vs. Private Equity (Priority: 4/5): Discussion on why venture capital sees more spin-outs than private equity, attributed to lower barriers to entry, smaller fund sizes, and less institutional scale. Due Diligence Process for Emerging Managers (Priority: 5/5): Gallagher details his LP due diligence, including founder references, ranking investors on a dollar-for-dollar basis, and assessing GP time allocation and operational capabilities. Reserve Strategy and Portfolio Construction (Priority: 4/5): Debate on optimal reserve strategies, advocating for a 70/30 first-check-heavy approach over the common 50/50, and the importance of selectivity in follow-on investments. Collaborative Checkwriter Philosophy (Priority: 4/5): Gallagher promotes a diversified, collaborative approach where emerging managers write smaller checks and add value through network and support, rather than competing for lead positions. Building a Business as a GP (Priority: 3/5): Emphasis on operational excellence, including hiring CFOs/COOs, structuring partner compensation, and maintaining a steward-of-capital mindset to ensure long-term fund success.

Key Arguments: Family offices face adverse selection when investing directly; fund investing leverages VC expertise and networks. Venture capital spin-outs are more common than PE due to lower capital requirements and fewer institutional resources. Emerging managers often underestimate operational demands; time allocation between fundraising, sourcing, and portfolio support is critical. A 70/30 reserve strategy (first-check heavy) is preferable to 50/50, as it allows more selectivity and reduces signaling risk. Founder references are a powerful due diligence tool; asking 'dollar-for-dollar, where do you rank this investor?' reveals true value-add. Concentrated portfolios increase GP risk; delivering consistent 3-5x returns is more sustainable for raising follow-on funds. Collaborative checkwriters can punch above their weight by providing value without needing lead positions.

Data Points: Average PE fund size in 2021: $1 billion - Reference point for scale differences between PE and VC. Typical emerging manager fund size: $5-15 million - Range for first-time fund managers spinning out. Recommended reserve allocation: 70% first checks, 30% reserves - Gallagher's preferred strategy over the common 50/50. Number of portfolio companies: 20-30 (common), 40 (Gallagher's preference) - Comparison of typical vs. diversified portfolio sizes. Maximum single-company exposure: 10-15% of fund - Guardrail suggested by host to manage concentration risk.

Pivotal Quotes: "I think one of the reasons Fund Ones performed so well historically is because those individuals have been so close to the ground that they aren't predictors. They actually see today perfectly clearly." — Ben Gallagher: Explaining why operator-close GPs outperform in early funds. "Mediocre returns and excellent client servicing is really all you need." — Ben Gallagher (attributing to David Rubinstein): Highlighting the importance of LP communication over pure returns. "On a dollar-for-dollar basis, where do they rank on your cap table?" — Ben Gallagher: Key due diligence question asked to founders to gauge GP value-add.

Implications: LPs should prioritize emerging managers with operational backgrounds and collaborative strategies. GPs must focus on time management, transparent communication, and disciplined reserve allocation. The venture industry benefits from diversified, founder-centric approaches over concentrated bets.