Debt Financing & Venture Capital: An Unlikely Synergy | Ali Hamed of CoVenture

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November 18, 2021

Ali Hamed is a Partner at CoVenture Holding Company LLC. Since his college days he’s been building an impressive network and unsurprisingly has built an impressive business.

What’s unique about CoVenture’s model is that they’ve found an interesting synergy between debt financing and venture capital. In addition to making venture investments, Ali and his team provide balance sheet capital to innovative companies that are financing new asset classes. As CoVenture puts it: “CoVenture partners with founders who are inventing new asset classes, identifying new economies, or who require alternative types of capital to grow -- and backs them with venture capital and/or debt financing.”

If you’re interested in the business models of venture capital, debt or general finance I think you’ll find this conversation to be educational. I certainly did.

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Transcript

MPD: Ali, thanks for being here today, man.

Ali Hamed: Thanks for having, yeah, I'm flattered to be on.

I feel like this is a good excuse to catch up generally. Yeah. We're way overdue. It's been years. I know. I do definitely remember writing you like these cold emails as an undergrad, because you were like one of these like hot shot and your tech guys were like, oh my gosh, like, how do I be like you one day?

So it's very cool and flattering to be able to have this conversation with you now.

MPD: That's awesome. I don't remember those. But only just like straight, a lot of them as you all, do you probably get a lot of emails like that now?

Ali Hamed: You can keep track of it. I find that I'm the ones that get the best responses are the one with ones with the most specific asks like the how do I get a job in venture?

Capital email is always like a very hard one. The, Hey, do you know anyone at this company? Because I like it for these, this reason. And I'd like to work, there is an easy one to help with. So maybe that was my mistake. I needed to make my asks more narrow as the the young cold emailer. Yeah. I,

MPD: what I did is I still get a lot of the generic general questions.

I started producing content to answer the most common questions. And then I send people a link

Ali Hamed: that I have

MPD: like an hour video or half hour video on my PA on my blog, which is like how to get the job in VC because everyone asks that. And it's 10 slides on how you get the job in VC. And I just forward the links.

I want to help everybody. You can't possibly do 10 hours of meet and greet calls a day and get anything done. It's impossible.

Ali Hamed: That's right. The it's funny because I often tell people, I can tell you how to get a job in VC three years from now, and it is a journey. You know, and you know, it's when you find the silver bullet answer, let me know.

MPD: Yeah. I don't think there is one. I think it's an unfortunate reality, but hopefully you can, when you, I've tried to respond to everybody, hopefully there's a nice tone to it. Even if it's, Hey, I can't jump on a call at the moment. One of the negative and of challenges of our business, having this imbalance, the number of people who want the job versus number of jobs

Ali Hamed: that's right.

I'm still here trying to hang out with you. So I think you're doing a good job.

MPD: Awesome. I'm glad you're on. Do you want to start off by just giving, just a brief background? No, I know you've you haven't had many legs of your career cause you, you beat the pack and skipped all the way to home base very quick.

Do you want to give a little overview?

Ali Hamed: Sure. So I mean, growing up, I feel like my 16 year old self would be really disappointed by how nerdy mind 29 year old self became. You know, so I grew up playing baseball. I went to Cornell to play baseball. And while I was there, I just got hooked on startups and I started one and it didn't work out, but I caught the bug and, and I addicted and I was doing consulting and doing consulting.

Doing any odd job that I could convince anyone to pay pay me to do this sort of this goofy process where I'd run around to two events kinda by myself, which was always an odd thing to do, look at my phone and act like I was busy doing something until someone was willing to talk to me and asked them what they did.

And as soon as they told me what they did, I'd be like, oh, that's amazing. That's exactly what I do. And I think I can help you with that. And you know, I do these random projects, building apps, or helping people set up offices in cities. They didn't know well. And and after that, I I finally saved up a tiny amount of money where I want to start doing angel investors.

And those angel investments wouldn't have been very productive because if I went up to someone like you, who is well known in the New York tech scene, and you were invested in this hot shot company, I said, Hey, my name is Alia. It's really nice to meet you. I had this wonderful experience at screwing up a startup, and I'm a junior in college.

You should let me into this hot deal. I feel like that'd be like a pretty poor pitch. And so instead what we started doing was building software for equity and founders who are non-technical because we knew how to build product and a lot of people didn't. And and that was our kickoff, that, that was like the original co-venture.

And, uh, we started it my senior year. And you know, I always joke, I go back to college reunions and stuff and people ask me what's new and there's nothing, I have the same job I'm with the same girl. I live in the same apartment. I feel like I've had this incredibly monolithic life since school that's because you skipped all

MPD: of the failures and confusion along the way and went right to the wind.

I'm sure. You found the right lady from the sound of it. You just got married.

Ali Hamed: Congratulations. Thank you. Thank you. It's still, it's still married three months later so thrilled for that

MPD: a hundred percent success

Ali Hamed: ratio so far. That's right. That's right. And yeah, definitely. I'm sure. I'm sure I'll get everything right from this point forward.

That's

MPD: amazing. Oh, look, I think it's a great background. I think it would be helpful for everyone listening to get a little bit of a headline about co-venture. Would you do an overview of the

Ali Hamed: firm once you guys? Yeah, sure. Um, at co-venture, you know, I guess even more broadly in my background, I helped manage two different firms, co-venture which provides credit to startups and we do it out of two different types of pools of capital.

You know, we do asset backed. Asset-backed credit doesn't mean that we do venture debt loans. It doesn't mean we do corporate loans. I started doesn't come to us and say, Hey, we raised $20 million from index. Can you give us another $10 million to extend runway? Instead, what it means is it's a technology startup, that's originating some sort of loan or asset, or come up with some sort of idea and we provide the debt financing behind them.

So an example that might be pretty well known is a company called Clearco finances, a bunch of e-commerce businesses. We were early and continue to be early providers of capital to them so they can finance those assets. You know, produce pay would be another purse, pay finances Latin American farmers who grow produce, we don't lend money to produce pay.

What we do is we provide them the capital. They use to private financing to those farmers. You know, and so we like all kinds of, esoteric or novel or interesting assets and we provide the debt financing behind it. And then we have another strategy where we it's more of a go anywhere strategy, special situations, complicated ideas, structured preferred equity.

As in venture capital generally has done a good job of figuring out what tobacco, but it's pretty unsophisticated in terms of how to back it. And we consider ourselves a small little team that can go from a 10 $25 million checkup to a $300 million check and give you any kind of capital you need when it doesn't when it doesn't fall right down the middle of normal venture capital.

Right. But the $300

MPD: million check is not when people hear that it's not a series E traditional growth check. You're giving a pool of capital. They can draw on. It's more like a tool than it is an

Ali Hamed: investment in the company. That's right. The really boring version of it. It's called it's an delayed draw asset backed facility.

And so what happens is the technology company will do a bunch of stuff. They'll go make a loan and sell into an SDV or they'll provide an advanced and we'll find an out. And if the technology company is like a holding company or like the C Corp, they set up a subsidiary, which is an SPV and they put the assets into the SPV and then we provide the debt financing to that.

However, we do have pools of capital where we can go provide a lot of capital to the corporate and allow them to do something. Now it won't be, we're just using it for general purposes. Usually they're making an acquisition or they're doing a roll up of some sort of assets. So we like to think of ourselves as like a blank canvas.

And we just tell people like, Hey, it sounds like you need a lot of capital people. Can't figure out exactly what you need it for. It's too complicated. It's too weird. Come to us with anything you want. And there's going to be a pool of capital there for you. And it's a really fun job because we, look at things all over the world and weird kind of asset classes.

And it's usually something where we often say that what we do is usually unpriced not mispriced. It's usually something no one's ever even done before. And so, so we just have a blast kind of learning a lot through that.

MPD: So is that, but there are other firms that do this, like we're investors in EasyKnock.

Easy knock essentially has made a very humane version of a reverse mortgage product. They're helping people get assets and liquidity out of their homes. If they have financial need for many their homes or their single most significant asset in general. And in order to do that, they needed a ton of capital that wasn't actually an equity investment.

It wasn't part of their operations. It wasn't used for their company. It was used to transact, right? Another company we're involved with this properly. It does, it has a similar type of dimension to it. Those I, the people I've seen come up and do those checks or the big banks I've seen hedge funds. And one of the BlackRock or Blackstone I was going to confuse Goldman.

Those are the players in there. Is that what you're bumping up against? Or who else do you see in this.

Ali Hamed: So, so we've seen everybody. But I think what I would encourage you to think about is what is the actual asset in a reverse mortgage? Like reverse mortgages are newly humane, but they're not new, reverse mortgages are generally, the type of asset where somebody who's elderly, might need some capital or their family needs some capital.

The only asset they have is liquid. So let's make them alone, against the asset and it's pretty expensive or punitive. And there's weird things about how you know, what happens to the asset after sadly you're reading against the person in many cases. And the end of the day, the asset you're secured by the house.

Residential real estate is not a new asset class. However, you in our case, perishable produce is there's no such thing as perishable purposes and asset class. And for really good reasons, if you lend against perishable produce, it goes bad. But prudish has figured out all these bells and whistles that actually make it a financeable institutional asset class altogether.

And what ends up happening or Amazon third-party sellers is another Amazon third party selling. Wasn't it. In 2011 or 12. And so it's just a brand new asset class. So you clearly have even institutionalized it by then. And a lot of these cheaper sources of capital, whether it's a bank or an insurance company, we'll come back to groups like, BlackRock, Blackstone, et cetera.

In a moment, part of what they're trying to do is they're trying to buy assets with good risk rewards. Part of what they're trying to do is also buy assets that fit within the regulatory framework that they live under you. An insurance company has capital charge issues. You'll pay your premium, and it's only happened at your house, the insurance company better give you the money.

And so there's all these rules about what they can put their money into to make sure they have the capital that way, when something happens, it's there. And but, but you kind of like a lot of rules and regulations, there's inflexibility, and one of the uh, general assumptions that financial regulations often.

Is that the longer the asset class has been around, the safer it is. There's more track record. It turns out people have been living in homeless for a really long time. So it's not like residential real estate is like a new asset type. And so for, for those types of assets, you actually can get them rated and put them into an insurance company.

A regulator will look at a bank and consider it tier one capital. So you can use depository capital, something like perishable produce or an Amazon seller, because it hasn't been around long enough. It's very hard for it to get rated and then sell to the abs markets where there's a lot of these hedge funds or securitizations that can happen to bring down cost of capital.

It's very hard to bring that into banks. It'll happen, but often it takes time. So what we find is that we're not always efficient for something like a reverse mortgage asset, as an example. And by the way, a long duration asset has to be fairly low yielding. Otherwise the interest would eat into the entire you know, margin that you're paying.

But what we often tell people is send us. Because what we've found is the technology world, generally, wouldn't be able to give you, even within Blackstone, how Blackstone works, should you go to bam? She got to be soft. She'd go to GSO. She'd go to tack ops. She'd go to the real estate fund. Where does GSO and tack offs overlap.

Like we'll teach everyone where they should go, even if it's not for us. So we just tell people, bring us everything, and then we'll tell you where to route it. And so what I'm hearing

MPD: from you, which isn't very interesting is you're specializing in lending against not risky assets, but not easily under rideable assets because they're new

Ali Hamed: we're often looking for is an asset type that feels brand new.

Exactly right. Where we don't think it's riskier. We just think it's novel. But what we can actually do is we can say what does this remind us of Amazon third-party sellers is a really easy one is an Amazon third place home. What does that mean? What if Amazon shuts that down? I'll be at the end of the day, these are small businesses.

They sell stuff online and they have EBITDA. If they're any. And we lend in normal direct London, like in corporate buyouts, you do all these really big loans where there's like an equity sponsor, like a private equity fund. They put in a hundred million dollars. The lender puts in $200 million. And the two things you use to underwrite, those deals are a loan to value.

The lender puts in 200 or $300 million is a 67, 66% loan to value. And the debt to income is basically the amount of EBITDA that company is generating compared to the debt that's outstanding. So the private equity fund, bought that deal for, 10 times EBITDA. You know, they bought it for $300 million.

It was earning $30 million EBITDA and there's $200 million of debt there. You know, it's like kind of an eight ish debt to income. That's pretty wide. And what they're relying on is the loan. In the Amazon ecosystem because companies are generally newer and they're bought by for lower multiples for all these different reasons that we can talk about later, you can provide higher LTV financing, but you're still doing the same thing.

You're just lending money secured against EBITDA using the debt to income, a debt to income covenant. So it sounds funky. It sounds weird at the end of the day, we try to take away all the noise and figure out like, what is this thing actually, you're

MPD: good at abstraction, distilling it

Ali Hamed: down to what it really is and speed, I mean, we'll, we've written, I think even a couple of weeks or we, we were an $80 million check within 24 days of meeting the company.

You know, and so we can move really fast, which is also rare for, a more, um, regulated institution perhaps.

MPD: And when you're let me get, get a sense here. So I know you guys are writing some pretty big checks and running a decent bit of capital here. What's the, what bucket do you fit into for LPs?

Are you more an alternative ass. And they're trying to think of you and looking, looking to underwrite you with some 25% plus IRR, or are you more bucketed with the debt players where you'll see lower returns? How do you fit within that schema as people get to this? Because it sounds like cutting edge ventures, maybe riskier, at least optically, but it's a credit

Ali Hamed: product, which is, yeah.

So if we had our druthers, people would put us in their asset backed bucket. If we think about walking up the risk spectrum, and one of the things, we haven't gotten to is we also do venture capital and, and one of the things I don't think enough venture capitalists do is really just think about pricing and what kind of risks should they be taking and why are the IRS are targeting makes sense.

And I think one of the things that credit has taught us is really how to, where to sit and how to think about where you sit in the kind of risk spectrum. You know, there's treasury. And then there's like high yield or excuse me you know, uh, investment grade, and then there's like high yield.

And then you start getting this stuff. That's a little more alternative. You get to private asset back, which might be, seven, eight, 9% type net returns. You have things like direct lending, which by the way, are like mid single digits, but levered to high single digits or low double digits, maybe high single digits out of defaults.

And then you have things that are more like esoteric, weird types of asset backed credit, where people put us in like the low double digits net back to investors. And then you have private equity which ends up saying that it's going to earn you a mid teens that return, and usually ends up getting you a height, low double digits net return.

And by the way, that's like on an IRR basis and there's a lot of cash drag and whatever it might be. But, but the IRR seemed great. And then you have you know, growth equity, which is high teens, and you have venture capital, which is low twenties, allegedly. And so, you and then a lot of people will put us in their absolute return bucket, which is a, we want an uncorrelated asset type, and we think that perishable produce and Amazon third-party sellers might be, different types of risks just using those because, I've already talked about them.

And so they liked that we have this diversified income stream you know, that's sort like an absolute return type profile. So my hunch is we tell people to post in their asset backed bucket and they nod and they smile and then they go back to their investment committees and they say they're kind of asset backed because even at the technology startup, where to go BK, they're secured by the assets of the assets are self-liquidating and there's a loss coverage ratio on all these other credit metrics.

But they're earning the same returns as a private equity fund. So maybe we don't think it's as unrisky, as they're trying to. You know, so maybe it's not as risky as asset or as risky as an asset backed, but it's certainly maybe not as risky as private equity. And so I think they try to triangle us into those and that's all my own assumption.

I'm sure every single firm and allocated as your own way of thinking about it and what we hope to get may or may not be what we get. So we just have to be careful about you know, w where we just view ourselves and taking a rational approach to the market.

MPD: So psychological, when you're going to deploy a product like this, especially on the credit side, I think the mindset is pretty different from the venture capital side of the house, which I know you're in as well.

And we'll talk about in a minute, is the goal on every deal to hit it out of the park, or is the goal to consistently hit a yield in the, you teens zone that you're targeting and show consistent?

Ali Hamed: Um, maybe putting on my, more talking about the asset class side of the house, I would say most lenders are often trying to figure out how do they create the most absolute dollars of alpha or absolute dollars of alpha type income, not the highest IRS.

And if you think cause if I wanted or if any credit manager, one of the highest possible IRR possible they would just make the fund really small. The reality is it doesn't serve a lot of needs and by the way, I have. I have LPs. I'm sure everyone else has LPs who want to put a lot of capital at work and they'd be frustrated and say, Hey, look, it's really great that you actually even let's talk about e-commerce and compare advertising to it, right?

If you went to an e-commerce company and they told you the CAC to LTV was like 10, they're, they're earning $10 for every $1. They put it and you take great, spend more. I don't want that high of a return. I want you to create more income, not more like your ratio is already good enough.

Like you're not impressing me anymore that this can't scale. And we're the hardest thing to do in early stage. Investing with direct to consumer businesses is figure out like Candice strategy. That's earning a lot right now. Continue to earn more at scale. I think a lot of credit investors say, what is the most capital I can put outstanding where I'm still generating some excess return relative to similar risks in my asset class.

And when people talk about credit, they talk about things like a 10% return, 11% return of 9%. And it sounds like you're talking about a hundred basis points. The reality is you're talking about 10% of your total. Yeah. One of the things that I think is really goofy about venture and credit is venture gets such a hard time for excess valuations because people are really bad at comparing numerators to denominators.

And it turns out like Americans are really bad at fractions. Like those denominators sound like small numbers, but they actually have crazy impacts on like the vector that you're on. And so I would say that the average credit investor, more often than the old school venture investor, although that's changing with firms like tiger, and some of these others is to generate the most absolute dollars of income that exceed the benchmark for their asset class.

And if they can earn a 18 on a hundred million dollars of capital or a 14 on a billion dollars of capital, it might make more sense to earn the 14.

MPD: So interesting. But I agree with you. I think most people are solving for that and that's the paradigm that leads to a lot of the venture guys. And again, we're, we'll flip over that in a second.

Oh, over raising. Oh, over-funding a strategy. They find a mousetrap that has a great. Then they keep raising as much as they can until they asymptotically approach the market low. And as long as they can hit that in a stable way that might optimize for total payout for them versus maximizing the return for their investors.

So it's a sign of misalignment to a certain

Ali Hamed: extent. So I'll take another point of view. I think some funds are under raising. So if I let's imagine I was a fully altruistic individual. I had no incentive in making money for myself and I had one LT and that one LP was the best non-profitable time.

They didn't spend any money on administration. All the money went to a good cause let's assume that we all universally agree on what that causes. What would my job be for them to make as much money as I possibly could. And if I sat there and I said, Hey, I have a hundred million dollar venture fund and it's 10 X in.

Every time I raised my phone. And th the LP said gosh, you we have a billion dollars and you keep taking a hundred and we're so happy for everybody. Cause it's helping the kids or helping whatever. Cause we're doing, do you mind taking 200? And I said no, I can't take 200 because I had only eight X my fund.

They'd be like that's great. We done $1.6 billion back instead of a billion dollars back and be like that's okay. Just find other people say we can't, you're the only one that can earn that kind of return. In fact, I would cause that me being almost like, putting my own interests ahead of their interests lifestyle.

I liked that they love me. I like to can I, I can trot out these ridiculous returns. I don't have to fundraise, but I just think it's not one or the other, like the job of an allocator is to align themselves. Tiger might be, I should do the best thing for their LPs. They might say what else you can do in the market is either us or a bunch of.

And and so you should actually, we should actually set up the vehicle for you where we can make as many dollars above what you should be making for this risk as possible, even if it means lowering the cost of capital for our asset type. So maybe maybe intentionally provocative, but I don't think it's as obvious as saying raising money more money is bad.

No,

MPD: I think actually make a good financial economic argument. The challenge is it's usually that there's a curve to that. And a lot of people, when they raise from 100 to 200 million, they donate exit. They go from 10 X into two X-ing right. And they're destroying a total absolute dollars.

Ali Hamed: I completely agree with that.

You know, and one of the first thing that was ever told to us when we built our firm, which I thought was a kind of a goofy line but really resonates is, running a billion dollar AUM firm is a great business to be in. Unless you raised this. I used to run a $6 billion AUM firm. It's really hard to go back.

Yeah, I think it's hard for momentum. It's hard for the team culture. It takes layoffs it or not of just pay cuts and individuals, employees, people at your firm want for progress. So I think I appreciate and resonate with the concern of growing too fast. What I don't resonate with is no incremental growth.

And I often find that a lot of firms are not run by their founders anymore are often incentivized to just do whatever the founder would have done. You'll firms like Andreessen Horowitz or some of these others. Part of the reason they're so entrepreneurial under evolving first rounds and other is because they're still run by their founder.

And like people will follow mark and Ben to like the dark Knight because they're the founders. I think it's going to be really challenging. And every firm has this, that when the founders leave the mission and by the way, this is true for companies to the mission is to do whatever the founder would have done.

Especially the founder wasn't kicked out. The founder was just, um, sunsetted or. And you know, I think it's just complicated and I agree with your point where it's not about growing 20% each year, 50, a lot of firms grow 10 X or two X each year. And that's when it gets really tricky.

Okay.

MPD: So you said you want everyone with an asset backed credit, need to call you and you'll help route them. So if you're listening to this, call them, okay, here we go. What are you actually looking for when someone calls you, how do you evaluate to determine whether or not it's a fit or not?

Ali Hamed: Yeah. So when we're looking at a company we try to figure out like, what are the risks we're taking?

You know, and and, and we're looking for things like let's talk about let's talk about SAS lending. The SAS lending is a hot topic right now. So in assassin, basically, Vista came out with this quote you know, for SAS revenues, better than firstly debt, because you probably keep paying your AWS bill before you'd end up paying your interest payment because you need your AWS bill to even keep your company alive.

And your creditors would probably agree. You probably wouldn't pay your AWS bill. If Amazon went bankrupt, if the provider of the software suddenly went out of business. And so we often spend our time thinking like, what is like the fallacy or what is the argument we're being given? And then what is, what are we actually underwriting?

Now? It turns out SAS businesses are generally good businesses to underwrite. They have sticky revenues, they have high margins. They at scale become a machine. You put a dollar in and you get a dollar back. And then we, so we, we try to figure out like, what is the risk we're actually. And then we say what does this remind us of?

You know, and so in the case of Amazon third-party sellers, it sounds wonky. Like you're selling you're, you're funny, like potentially eBay sellers but then you look at the track record, you look at the actual default rate and you say, this is small business lending.

What kind of default rates do we see in normal, small business lending? Especially if those debt to income profiles and just a lot of data you can find there. So then we take, what is the comp in the market? And then we say, what is the first party data we're actually getting from this company? And do they match you?

And Jeff business has this wonderful quote of if the data in the story don't match, just stay still, or trust the story. You know, we struggle when the story doesn't match the data that we're actually receiving. And then we want to have an aha moment. You know, why is it that a like the risk we're taking is just so outsized, a reverse factoring is a great example.

So you can go to let's imagine a large company like. And, this is sort a random example that, that we obviously don't do, but you said, Hey, Uber, your drivers are all owed money by you. Why don't we make your drivers alone secured against the payment you owe them? You end up doing, as you get paid, like you're taking the risk of the consumer who drives for Uber, but you're actually taking the credit risk of Uber itself.

And it's definitely a spread. So we look for a lot of those like aha moments. What's an example of something that we can earn a really good spread. And then we want to understand how can we get it to scale. And then also we want to make sure that if we're able to get a really good deal, how is that deal good for the company itself?

Because you can have