The Inquisitive VC: Brooke Pollack — Hutt Capital
Brooke Pollack is the Founder and Managing Partner of Hutt Capital, a blockchain venture capital fund of funds and direct investment firm. Prior to Hutt Capital Brooke worked at Greenspring Associates and various other LP centric organisations.
We talk about why this is the right time for a blockchain-focused fund of funds, mistakes made by emerging managers when pitching to LPs, the risk strategy for Hutt Capital and Brooke’s view on how COVID-19 is impacting the venture world.
NA: HI Brooke, first of thanks so much for joining me today. To start off, I thought we could just talk about your background a little bit and what actually got you involved in the blockchain space.
BP: Thanks for having me Nawaz. My background, prior to starting Hutt Capital was 10 years in the Limited Partner (LP) world, either as an LP or within LP centric organisations. I started my career in Portland, Oregon, which is where we’re based with Hutt Capital and where I’m from.
I started working for a family office consultant. I worked specifically on the private markets team, where we helped family offices to invest as an LP in private funds. That was anything that was illiquid and not a hedge fund.
I ended up leaving after a period of time and moved out to the East Coast for a few years. First to a firm called Hamilton Lane. I worked on the secondary team. We would buy LP interests from those who need liquidity, helped GPs restructure their funds, helped captive venture and private equity firms to spin out, become independent, and give them some additional capital and runway.
I was there for a couple of years and then had the good fortune to join a firm called Greenspring Associates, which is a venture capital platform with over $10 billion under management.
They invest as an LP in a wide range of venture capital funds. They buy LP and direct secondaries as well as doing growth stage direct investing all within venture. I got to do all the above there for over four years. I also helped, in particular, to build out their secondary business.
Most relevant to Hutt Capital, the last year I was at Greenspring I spearheaded their efforts in the blockchain space. That came out of long personal interest. I had gone to school with a couple of guys who were very early in the space, but for a long time, it was purely personal interest and it was completely irrelevant for my day job.
When I started doing venture full time in 2014, it was more relevant, but we still weren’t deploying capital in the space at that time. It really picked up in 2017, when we started seeing a lot of these venture funds that were dedicated to the blockchain space emerge.
I saw that and decided to go out to get to know all of these firms and build those relationships and spent much more time truly digging into this space, on education, and building out my network.
I was thinking about the future and I felt like a lot of the areas that money had been made by venture funds were becoming more saturated and overcrowded like software, marketplaces, and eCommerce and such. As I looked to where the real money will be made over the next 10 to 15 years I came to the conclusion that blockchain was the answer to that.
So I wanted to dedicate my full-time attention to that space. I ended up deciding to leave and start Hutt Capital. We’re a blockchain venture fund of funds and direct investment firm providing diversified exposure to blockchain innovation.
NA: That is quite a journey. You’ve been in this space for quite a long time, which is pretty amazing. To pick up on the Greenspring side of things, are you able to talk about what was, Greensprings, first blockchain fund investment, and why you guys make it?
BP: Yeah, I can speak to aspects of it. If you look at Greenspring’s website, you will see the Blockchain Capital logo there. So we did work with Blockchain Capital and that was one that I sourced and was heavily involved in a while I was at Greenspring.
I can’t say for sure what they’re doing now, but that was the only dedicated fund that we worked with while I was there. We didn’t make any direct investments in blockchain specifically while I was there, we did some investments in FinTech and adjacent areas.
NA: Got it, and now that you’ve moved out, and started Hutt Capital, why do you think this is the right time to build a blockchain-focused fund of funds?
BP: As I was looking at the market, nearly two years ago, there was a growing number of early-stage venture funds and basically all the funds in this space are early stage because that’s where the opportunity is given the maturity of the market.
A year ago, there were 49 dedicated blockchain venture funds, and today we’re tracking 66. So there’s a lot of funds out there that are on a dedicated basis pursuing this space and a lot of very high-quality funds that I’m very excited about as well.
I was thinking about where’s the market opportunity for Hutt Capital and for myself and realized I had a very unique background as an institutional LP, doing that for 10 years I effectively had a master’s class in running a venture fund of funds for a little over four years at Greenspring.
There was no one else in the market with the model that we have and it was a very unique offering, one that I felt would resonate very well with investors. I felt the risk-return for the fund of funds model was very compelling in this space. There was a first-mover opportunity to go out there and take advantage of that.
NA: There has for sure been quite a large increase in the number of blockchain-focused venture funds. In your experience in a broad sense, where do you see most prospective fund managers fail when pitching to LPs like yourself?
BP: That’s a good question. I think probably the biggest thing is if you were an LP, even if you’re a dedicated venture fund to funds like Greenspring, you’re talking to such a huge volume of managers on an annual basis. In order to attract attention and eventually attract capital, you have to really stand out.
The market for venture funds is more competitive than ever. I think funds really need to think about how they are differentiated and just because you’re a smart person who knows how to invest capital, there are lots of people who fit those criteria.
So, you really need to find a unique model, a unique way to position yourself as a firm. What really makes you stand out amongst hundreds of your peers who look generally speaking relatively similar.
I think for a lot of emerging funds they underestimate how much they should be doing in terms of differentiating themselves and really being creative around finding new models, new approaches, and new ways to market themselves and position themselves. Money’s not just going to come to them because they’re smart, motivated people.
NA: That’s a great insight. Is that the same with the crypto/blockchain-focused managers.
BP: Even though there are more managers than there were before, the lower quality managers have gone away and the quality has grown quite a bit. You still see it today, but especially a couple of years ago, you saw a lot of folks who made a fair amount of money in crypto, they were early in Bitcoin, or they traded ICOs and made a ton of money before the crash. And they’re like, “oh, I’m really good at this. I should start a venture capital fund.”
They may be underestimated the difficulty of raising a first-time fund, especially if your track record is that you’ve made a bunch of money on Bitcoin which doesn’t really translate to running a successful venture capital fund.
That was a unique thing that you saw in this space, which fortunately you see less of these days. Generally speaking, the firms in this space have lesser track records, so it’s a bit more welcoming of emerging managers because everyone’s kind of an emerging manager.
I think that’s the benefit of being one of the early movers in this space as an emerging manager. People don’t expect you to have that 10-year track record of investing in the space because that is inherently impossible.
NA: When it comes to raising capital for your fund are you still in that education phase for institutions? Are you still trying to explain and educate them on the value of this opportunity?
BP: Yeah. It’s all over the board, as you can imagine. I would say, generally speaking, we are still in the education phase and it just takes a while for a large institution to get up to speed on a new asset class, a new space.
Not only to decide that they find it interesting but then to convince their team or whatever the governing body is to actually allocate capital. It takes a while. In the past couple months we’ve definitely seen some of the institutions refocus a bit as their portfolios were declining in March and I assume they’ve recovered pretty well since then, given the public markets have been strong, but, the research and education of the blockchain space, at least for some, not for all, certainly took a pause.
NA: When it comes to making investments out of the fund, what do you look for in terms of a risk strategy for a potential fund investment?
BP: On the risk side we’re a fund to funds, so we aim to be a lower risk and lower volatility way of investing in this space.
We’re not looking into taking huge risks in terms of our investment approach. I mean, inherently in this space, you’re investing in early-stage companies in an emerging category. So it’s inherently risky. We only invest in closed-end venture funds.
We don’t do anything on the hedge fund side as a fund to funds, it is more equity-oriented. It’s much more focused on long term value creation, in a more traditional venture capital way versus speculation on crypto assets.
With equity, you don’t have the big shifts in, the public asset prices of holding a lot of crypto. Like you might see on the hedge fund side. So that’s a big piece just in terms of long-term steady value creation. From a risk perspective, we also look to diversify across different use cases for blockchain.
We diversify globally. We have to be very comfortable that from an operational perspective these funds will be strong and have a good management team and know how to run the business, as most of these are emerging funds.
NA: When it comes to the size of funds that are raising in other markets, I imagine it’s quite different from the traditional VC size of funds in the US. I’m talking from my experience in New Zealand, the average fund size here would probably be like a micro, micro fund in the US. So, how much allocation in a fund is generally required by a fund of funds?
BP: I wouldn’t say we have a specific fund size that is required for us to be interested. and generally speaking, the funds in this space are much smaller than traditional, non-blockchain venture capital funds.
We actually wrote a piece on this, but I think the median fund size is in the thirty millions. So let’s say maybe $35 million and the average is maybe $65 million in terms of the funds within this space.
That is pretty small relative to the broader venture market, which is relatively flush with capital these days. There are a handful of funds that are over a hundred million, but the vast majority are under 50 million terms of fund size.
There are quite a few small first-time funds. If you look at the data historically, if you can get access to a lot of the emerging managers who do still have those smaller first-time funds or second-time funds before they become these brand names.
That’s where a lot of the big returns have been made by venture LPs historically. So, I see that actually as a pretty attractive opportunity, obviously you have to do work and pick right in terms of which funds you work with. But, I think it makes for a very compelling opportunity from an LP perspective.
NA: Sure. A bit about your thoughts on geography. Do you think the best kinds of deals, the best fund managers would be in Silicon Valley or the US? What are your thoughts on that?
BP: The majority of venture funds focused on this space are based in the US, which is something like 70%. If you look at the funds that are based outside the US they tend to be smaller. There is a pretty big portion of the capital base that is sitting here in the States, but that said, if you look at the underlying deal flow, it’s much more global than the broader venture capital market as it’s all built on top of open source technology.
It was built at a time where technology itself was much more global than it was when the internet was built for example. Asia, in particular, has a larger piece of the pie in terms of start-up activity and startup funding. Given that it’s a very large market for the usage of blockchain and crypto.
So it’s a bit of a weird dynamic where most of the money is in the States and there are a ton of high-quality startups in the States, but it’s still important that you have a global view.
We look at funds in Europe and Asia in particular. There are not as many funds on a relative basis in those markets. Especially in Asia where historically the managers have had a more liquid bias broadly speaking.
You do have a pretty healthy manager set in Europe, but likewise, it’s not as well capitalised as what you see in the States, but there’s a lot of blockchain and startup activity out there. It’s an important place to have exposure to if you are building a strategy within this market.
NA: How much diversification do you need as a fund of funds in order to be low risk?
BP: We invest as an LP in 10–12 early-stage blockchain venture funds from the fund of fund strategy. I wouldn’t say there’s any specific number that makes it more or less risky, but not every fund warrants the same allocation, at the same time, you need to make material enough allocations that it’s worth having in the portfolio.
Typically on the low end, we might allocate about 6% of the fund to a manager and that’s not set in stone, but give or take that might be on the low end. On the high end, we might allocate about 12% to a single manager
That’s maximum and minimum, right? So that’d be quite a few of that in-between. I mean, we may or may not necessarily invest at that 6% or 12% level, but that would be the range that we would expect.
NA: How would you go about evaluating second-time fund managers who have finished investing out of their first fund. You can see their portfolio, but not really the returns from it. How do you go about evaluating that?
BP: Because funds in this space don’t have the same level of track record as the broader venture world, you are going to dig pretty deep on the track record in terms of, how they source deal flow and why they chose certain deals and how the portfolio is performing to date, even if it’s still young.
You’re also going to spend a ton of time doing references and working your network in this space to really get to the bottom of how are they viewed by entrepreneurs and not just the one that they put on the reference sheet, but doing a lot of off sheet references with other funds, entrepreneurs, other people in the space and really getting a well-rounded picture of how they are viewed by the market.
How they work with portfolio companies post-investment, all the stuff that you want to know about these funds and if you go through that process, you can get a good sense of who is really seeing all the deal flow, who are the preferred partners for the best founders to work with. That’s really what’s going to drive success.
You combine that with actually looking at their first fund and the execution side of it. That gives you a pretty good picture, in terms of forming a view, but you definitely need to put a lot more time and effort into the referencing side.
NA: My final question is about the current macroeconomic environment how do you think the whole COVID situation and the current environment is going to affect venture capital in general over the next one to two years?
BP: I’ve been talking to a lot of the underlying managers about this. With the recent environments and generally, if you’re investing in early-stage companies, this is being viewed as a very good time to invest.
One; valuations are just better than they were before. So, private market valuations have come down materially since COVID, and economic impacts have come into effect.
If you were an investor in early-stage companies you have the ability to invest potentially at better valuations than you did just a few months ago. Similarly, I’d say there’s a pretty consistent opinion that the current environment is driving a more rapid tech transformation than would have occurred otherwise.
While obviously the human economic toll of the situation is pretty devastating, from a venture investor standpoint managers are pretty excited about the investment opportunity that is being created by better valuations and more rapid tech transformation.
NA: What about more on the LP side of things? Are they still actively investing in venture funds? Would we see them investing over the next year or so?
BP: The past couple of months have definitely been a bit slower. This is anecdotal, but I’m sure you’ve seen the pace of investment come down in terms of investing in venture capital funds.
I do think you will see that increase. The public markets obviously have come up quite a bit and, if that’s sustainable or not, I can’t say, but I do think it helps to give some level of trust and help to offset denominator effect issues.
When the markets go down quite a bit people don’t like uncertainty, so the sooner that people feel like things are “going back to normal”, even if it’s not the exact same normal as before, I think the sooner you’ll see capital allocations pick up.
Now I do think based on what I’m seeing LPs are going to be increasingly comfortable over that time period, assuming we don’t have a kind of another large economic crash due to recent events.
NA: That is very insightful. Thanks so much for talking to me about this Brooke, it was very interesting to go into detail about fund of funds!
BP: My pleasure. Thank you so much for having me this was a lot of fun!
