SPEAKER_01: The amount of cash being invested in pre-seed and seed is now at a 13 quarter low.And the number of deals also has come crashing back down.
SPEAKER_02: I think last 10 years, everybody just went crazy.LPs went crazy.They forgot that there's a J curve.Managers deployed too quickly.Companies raised very quickly, spent too much money too fast without any new information, new milestones. doing venture.
SPEAKER_01: And this is, I think, the danger of how attractive venture capital can be.We never seem to learn our lesson or we forget it after 10 years.People get too excited, they put too much money in, and it breaks everything.
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SPEAKER_01: All right, everybody, welcome back to Twist.This week in startups today, we're thrilled to have Raja Dodala on the program.He runs venture and growth at Churchill Asset Management.We'll hear a little bit about Churchill in a moment, but we want to talk about the VC world and exits and how capital's being deployed.Raja, welcome to the program.Thanks, Jacob.Thanks for having me back. Yeah, let's get right into it.Bunch of data that will just level set with the audience.Let's start with the deal value in 2023.
This is the National Venture Capital Association and Pitchbugs data that we're showcasing here.And look at The number of deals that occurred in 23 versus previous years, and this is a quarterly chart.
SPEAKER_02: What we see here is that the deal count is sort of down from the craziness of 21 and 22.It's down, but it's sort of back to what I think is sort of a normal pace and normal amount of financings, I think.
SPEAKER_01: we're reverting back to our average 3,000 deals a year occurring.Whereas at the peak, we broke 5,000, you know, four or 5,000 deals going on per quarter per For a quarter, that's a lot of deals.And the deal values are what we see in the blue bars.So the value of those deals rocketed up to, looks like almost 100 billion deployed, 80 billion at the peak there.And now we're back down to the 40 billion every quarter being deployed in something around 3,000 deals.Wow. So the madness is over.We're back to what is normal.Let's go to the next chart here.
This will just show the yearly.And so if we abstract this on a year, it becomes even more pronounced.What do you see here in the yearly chart of deals and the volume of deals in terms of dollars?
SPEAKER_02: Just back to pre-pandemic levels.It's still a little bit elevated if you compare it to 2015, 2016, but just generally back to the mean, I think.
SPEAKER_01: Yeah, we're we had 170 billion in deals in 2023.Obviously, even though the number of deals has come back down, looks like 15,000 deals for the year.And we were averaging in that 2014, like 12,000 11 12,000 deals. So it's still elevated the number of deals, and it should be growing.Venture grows, capitalism grows, so there should be some growth, typically.Yeah, definitely.
SPEAKER_02: This is probably AI, round sizes, the valuations on round sizes are quite elevated, and that probably explains the deal value.
SPEAKER_01: So this is where you can start to get a little bit more granular pre-seed and seed deals here.This is Q4 pre-seed and seed deal value slumps to 13 quarter low.So the amount of cash being invested in pre-seed and seed is now at a 13 quarter low as of Q4.This is Q4 2023 data that's come in.And the number of deals also has come crashing back down.So when you look at this overall, Raja, a healthy thing, right? Very much so.
SPEAKER_02: Things were too hot?Yeah, very much so.I think the last 10 years, maybe seven, everybody just went crazy.LPs went crazy.They forgot.We, as you said, they, we forgot that there's a J curve.Managers deployed too quickly.Companies raised very quickly, spent too much money too fast without any new information, new milestones. Looks like we're back to sort of normal way of doing venture.
SPEAKER_01: And this is, I think, the danger of how attractive venture capital can be.When venture capital is a boutique industry, when we're doing a small number of deals, when things are concentrated and we don't have venture tourists coming in, people plowing money into venture because they get excited about it. When we don't have entrepreneurial tourists, people starting companies who, you know, hey, they might have been a great CMO, a great CTO, a great VP of sales, but then they get the CEO slot, maybe they're not cut out for it, and the talent gets spread a little bit thin.You know, you get a little spreading the peanut butter too thin, and then you don't have this, you know, talent.So on both sides, it gets a little too loosey-goosey, and it feels like this keeps happening in venture.Every... couple of decades, whether it's dot com, web 2.0.Now at this, you know, 14 year run up, we had, I guess what we're going to call the Zerp era, all three of these, we never seem to learn our lesson, or we forget it after 10 years, people get too excited, they put too much money in, and it breaks everything.Yeah.
SPEAKER_02: No, it's true.I think, you know, even though there's a lot of data that suggests that work, at least some of the industry is back to sort of normal art, you know, sort of boutique way of doing things.But if you look at AI, J. Cal, I think there's probably still some of that behavior still sort of people using AI sort of as a cover to still do that.Brian Singerman, I think was on your podcast.He was at a conference that I was at upfront a couple weeks ago.He basically said AI is uninvestable.
SPEAKER_01: And his thesis is why?Because the valuations are too high?
SPEAKER_02: No, I think his thesis is a little different.I think the way they do it at Founders Fund, they like to be non-consensus.They think it's completely consensus investing in AI.So he feels like for him, it's completely uninvestable.But from what we see, I think some of the... Reasons why, even though the deal count is down, the valuations are still record high for seed and pre-seed, even higher than 2021 and 2022.Our round sizes also haven't budged.I think that's probably a function of AI.
SPEAKER_01: And let's pull that up here.So this is where we can start to get super granular.We can actually look because we have some good data here.Now, PitchBook data is not perfect.And the NVCA's data, nobody's data is perfect in this regard, but it does show a decent trend.Carta also releases some good data.Crunchbase releases some good data and the fine folks at TechCrunch.So you can kind of triangulate this data and it all kind of will bring you to the same place here.This chart we're looking at here, these two charts, median pre-seed deal size remains the same as 2022.
So somewhere around 2019, we started to see the valuations of these, the deal size rather, how big pre-seed deals were, started to climb.In other words, more cash was given to pre-seed companies.So pre-seed company at a level set here, it's typically a two, three person company, two or three founders building a product.Yeah, we would agree.Yeah.
SPEAKER_02: Yeah, I think so.I think, you know, 600,000 is what looks like pre-seed, you know, that used to be, you know, just a couple hundred thousand back in 2013.And that's a 3x increase and that hasn't budged.
SPEAKER_01: And so when you look at this, this means founders at the pre-seed, select founders, are getting a larger dollar amount.And I am still seeing founders raising 500K.So it is quite normal to see a 500K round, I suspect, because these are averages.
SPEAKER_02: I mean, if you look at the 75th percentile, it's like a million and a half.You know, at the top end, it's like a million and a half.Are you seeing that million and a half seed round?Yes.
SPEAKER_01: I guess once in a while we will see somebody break out in a pre-seed and do a million and a half.What to me is shocking is then we have seed deal sizes, which is the second chart on the right.And again, those four lines we're looking at are 25th average, median, 75th percentile.And when you look at that 75th percentile, I mean, you're talking about raising 5 million, which to me is a series A. No, I think you talked about this in other episodes.
SPEAKER_02: I think the seed is the new series A.
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Terms and conditions do apply.What should a startup have demonstrated?In other words, what risk has been taken out of the investment at pre-seed? When there's, let's say, three founders versus seed, we know when maybe there's three founders, a couple of employees, and maybe products in market.How would you define these two?Because this is kind of a sticky issue.
SPEAKER_02: Right.So some of the best pre-seed, seed managers that we have in our portfolio, when I ask them this question, and they say the difference is, used to be, especially 21 and 22, just a PowerPoint deck and a founder, an idea.If it's especially a second-time founder, no questions asked, you can get a half a million bucks.Now you got to have a product and even maybe a pilot.If it's enterprise, maybe an early pilot or two.For seed, a real contract, like a real customer or two with some real traction and revenue is what they're looking at.
SPEAKER_01: Yeah, so Pre-Seed, just so we're clear here, the definition would be a couple of co-founders, they've got a proof of concept, a demo, and maybe somebody beta testing the product.They may not be paying, they could be on a pilot, but there's somebody giving some feedback.Whereas previously, Pre-Seed would have been the friends and family round.I would have defined Pre-Seed and friends and family as the same thing.Angel.We're just passing the hat, a couple of folks and an idea, a business plan, a mock-up. But because it's easy enough to build products now, people kind of get the prototype done.Then at the seed stage, definition is you got paying customers.Somebody took out their credit card and paid for it.And maybe you can even start to talk about growth.
Maybe they got 12 weeks.Maybe they got 24 weeks of people using the product.You can actually maybe dig into the engagement stats and see who uses the product every day, who uses it every week, who signed up but stopped using it. And so maybe everything just has moved over to the left one.You know, we're looking at here is actually a seed and series age seed and series.A deal's going on here is another part of this, the attractiveness of, historically of the seed round and the pre-seed rounds has drawn investors down.GPs are saying, you know what?Series A is too competitive.I'm up against Sequoia, Kraft, whoever, Lightspeed, you know, pick a firm.
They're all, you know... battling it out for the Series A. Maybe I don't want to get in that mix.The seed stage and the pre-seed, certainly, there's five to 20 people in the round.I just need to secure an allocation.I don't have to be the lead.I don't have to join the board.
SPEAKER_02: Is that what's happening here?I think you also said another sort of key word there is the lead.So where we see is two places that are super competitive. One, the lead position at seed stage.You're a seed firm.Then you're trying to sort of, you know, you started out as a $20 million sort of firm and you sort of graduated.You raised fund three.Now you have $125 million seed fund.And now your portfolio math requires you to get some ownership and a lot of times lead. And some of the platform funds are now sort of wanting to lead seed stage deals, and they want 12%, 14%, 15%, and that's getting very competitive.
And then Series A, obviously, is as competitive as ever.And in terms of metrics, used to be, yeah, some early product market fit, a couple of customers that are real.Now, they're looking at customer cohorts.Are there similar customers, more than three, four contracts that are sort of similar, meaning that the product sort of hit popularity with a segment of customers?
SPEAKER_01: So a little more predictability might be a way to say it.Yeah.So you got your third customer and they look like the second who looks like the first.And now if you got those three, you can just extrapolate from there the next 300 and then on to the next 3,000 and 30,000.And if you have a SaaS business that gets 30,000 customers at $1,000 to $25,000 per year, you got a real business on your hands.Right. That really is what I've learned investing is about.The price goes up, the valuation of the company, and your ownership goes down as the founders figure more things out and risk is taken out of the business.
SPEAKER_02: Yeah, you get more cards to build, definitely.Yeah.
SPEAKER_01: And so if you're pre-seed, you have no customers, valuation is going to be low single digits.Now you got three customers, all of a sudden your valuation starts to get towards high single digits.That's right. Now you start getting predictable.Now you've got an eight-figure valuation.And then if it's year-over-year predictable, you're in year three and you went from 100 in year one to 500 to 1.5, guess what?Now you get to have that $50 million valuation and qualify for the Series A. And so this is where founders, I think, I don't know if this is your experience, if you're a founder and you're aggressive, you always want to get credit for the next level of work, maybe work you haven't done yet. Because you're aggressive and you want to be recognized.And this is a hard, I just had this come across my desk, desk being slack, had a company we liked out of Foundry University, our pre-accelerator.We offered them to come to the accelerator, 125K for 7%, just like everybody else, like Combinator, 500 Global, Techstars, Launch, all the same terms, basically.
And they said, you know what?We got some angels to put in at, let's call it 7, 8, 9 million. And so, would you put the $125,000 in at that level?And we would say, you know what, maybe we'll wait for you to get to 10 customers, 20 customers.
SPEAKER_00: Yeah.
SPEAKER_01: Because you don't have paying customers yet.So, you know, and that just takes discipline.
SPEAKER_02: We might like the company, but, you know, they're… And that's your typical entry point, is it not, Jason?You know, where your accelerator is kind of where you try to get in and sort of build a portfolio and then sort of double down and they're sort of the winners.That's…
SPEAKER_01: Yeah, so this is like a great pivot point for us, which is portfolio construction.And so maybe just to level set with the audience, because we kind of got right into it.How do you invest?Who do you invest in?And then what are your expectations?And then I want to jump into the exits chart and then go into portfolio strategy.
SPEAKER_02: Yeah, so the way we think about it is, I mean, you had a couple of really interesting contrasting LPs on your podcast.You had Michael Kim, a sort of early stage, pre-seed and seed.Fund of funds.Fund of funds concentrated.They take a big chunk of the funds. And then you had David from Vencap, sort of very concentrated 12 sort of platform funds.Terrific 12.Terrific 12.That's terrific 12.I know you kept trying to get him to tell you which 12, and he wouldn't.
We're probably somewhere in the middle.The way we think about venture is there are really like three products in there, three asset classes, if you will. Pre-seed and seed is sort of a different risk profile, different stage of the company, really company creation stage.And then you have sort of series A through D that sort of really used to be sort of what used to be called venture.That's why I think PitchBook still calls it early stage, series A. And then sort of post-series D through IPO sort of growth stuff.We play in the first two.Pre-seed and seed is our one cohort. And then A through D. And the way we think about our own portfolio construction is series A through D. We think on a risk-adjusted basis, A is probably the best point of entry for LPs.So because of that, 55% to 60% of our total committed dollars, they go into series A through D. And the way we select managers there is very much like David.
We're sort of concentrated eight to eight, let's say 10, approaching 10 now.And we'll probably stop there.Those 10 managers, as long as they're doing well, according to the way we think about investing, they'll be our sort of marquee sort of names in the portfolio.Then seed and pre-seed, according to the historical data, returns are higher. in precedency.And so there's the alpha there, but also it's risky and it's volatile.Because of that, we sort of have a long tail of 20 to now approaching 25 smaller managers.Smaller for us is anywhere from 25 to sort of the top end, maybe top out at 100, 110. Total fund size, right?Yeah, total fund size.
SPEAKER_01: And that means you like to put $3 to $10 million into each of those?
SPEAKER_02: Yeah, $3 to $10.We like anywhere from 5% to 15% of the fund.
SPEAKER_01: Perfect.So 25%.If it's a $25 million fund, you might put in two or three.
SPEAKER_02: Two and a half, two million.We're willing to do that.And a lot of the institutional investors of our size don't like to... We see a couple hundred to 300 funds a year.It takes a lot of work. sort of sifting through what is that person's comparative advantage?Why are they going to get 3%, 4%, 5%, 7% ownership at seed and pre-seed?Are they going to be able to help them graduate, et cetera?So we think some of them will make it.Some of them won't graduate to fund three and four.But we think it's important to play in that space.
Because of that, dollars-wise, about 35% to 40% of our dollars kind of go into that space. But it's a long- The seed and the pre-seed.The seed and pre-long, you know.And then we like to, you know, just like, you know, you like to sort of layer in additional capital in sort of outliers.Yeah.We sort of have close relationship, you know, with our managers.And we like to do co-investments, you know, sort of post-product market fit, you know, reduce the duration. of the holding period, potentially lower fees, a little lower risk.These are companies that we technically will know beforehand and where we can get access.
SPEAKER_01: So you might see this company in a seed stage, and you watch one of your Series A funds invest in them, and now they're at Series C or D. They're maybe projected to be two to five years off from an IPO, and you can put in an extra $10 million or $20 million into that one deal?
SPEAKER_02: Yeah. we'd even do smaller uh what we like to do is you know we want to make sure that it's easy to make room for us um some of these rounds you may not there may not be enough room for 10 million but we're willing to do in a three-year period we'll probably do 25 to 30 of these some of them be one to one to five million range and more often than not More than one firm in our portfolio will be part of that at some point in that company.
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And so you then get to have that inside information.You've got comfortable with the founder.You've reduced massive amounts of risk.You may be nothing's guaranteed of course but no you may have reduced 60 70 80 percent of the risk they've now gotten to 25 million 50 million in revenue and it's a straight shot to 100 or 250 million in revenue which is when ipos i think can be considered now 250 million something in that range would be uh the floor for an ipo i think in today's market in the u.s obviously in other markets you can you can go out with 10 million in japan or
SPEAKER_02: Yeah, it's interesting.We can go into it.Exit values are really super interesting.
SPEAKER_01: Everything we do in venture is predicated on the money coming back at some point.Yeah.And you can have great periods where founders and LPs and GPs want to hold their position because things are growing and they have long-term greed.Airbnb is growing.Coinbase is growing.Uber is growing.DoorDash is growing.You know, they would just stay private longer, right?Stay private longer was the move.But then we saw...
Airbnb, Uber, Coinbase, DoorDash, you know, get out and eventually great IPOs that were a little bit sticky and it was a little choppy at the beginning.Maybe they were just overpriced relative to where they were at.But here we go. Maybe you could describe what you see in this chart, this quarterly chart of exits.
SPEAKER_02: Just to put it into perspective, I think the narrative is that exit environment is really tough, which it was.But if you look back, some of us have been around a while.The exit value was low.Total 2023 exit value is about $68, $70 billion, something like that, down from $800 billion almost in 2021. And that 2021 exit value is completely bonkers.That never happened before.That's a complete anomaly, and that's probably never going to happen again.
SPEAKER_01: I mean, we did have that dot-com era.A bunch of people got out, so you did have a spike there.As I like to tell people, fortunes are made in the down market.They're collected in the up market.A lot of what we saw in this crazy 2021 era were companies that 10 years earlier 2011 were invested in by folks, whether it was Robinhood, Uber, DoorDash, Coinbase, you know, the companies who went public.And then I guess M&A being turned off in the EU, the UK, and the US, and everybody just sort of putting the kibosh on M&A, that means IPOs is the only way to go. And we see something like the Adobe Figma deal get, you know, that was $20 billion that should have been consummated some year, maybe in 2023 somewhere.And so that $20 billion would have popped up one of these quarters, right?That's right.
SPEAKER_02: If it popped up one of these quarters, it would have come back in terms of LP dollars back in the system.But what's interesting, though, J. Cal, is that as bad as 2023 was, the total exit value, about $70 billion, That's not completely too far off.If you look at 2013, 2014, 2015, it's typically around there.It's just 21 and 22 are complete anomalies.And also the 87% of all exits, this is the last 10 years worth of data, starting in 2013, 87% of all exits are less than $100 million. Right.
SPEAKER_01: It really is the power law at work.Most of the exits, you're just getting cash back or half cash back.The preferred stack gets paid back.But nobody's really popping champagne corks here, except maybe pre-seed people who invested at $5 million.It exited at $100 million, $50 million.Yeah, maybe they got a 10x, 5x. It's okay, but it's not a 50X or a 100X, which is really, we need to be hitting 50 and 100X hits in our portfolio.
SPEAKER_02: And this is one of the reasons why I think we have 20 odd firms that are 25 to really 50 to 110 million range.I just did some quick math.If you're a billion dollar fund, And if you want to do 3x DPI net in 10 years, that means you have to create about $4 billion worth of exit value in 10 years.And that's about 14%, 15% IRR. That's not easy to do.
SPEAKER_01: It's double the stock market.So if you parked your money in QQQ or whatever S&P Vanguard fund, you would hit seven or eight historically.And so when you put that $4 billion there, you got a $4 billion in exit value because a billion is going to be management fees and carry.Right. Correct.Then you got $3 billion left net to your LPs.To hit that, if the billion dollar fund had 50 bets of $20 million, and that $20 million bought 15%, got diluted down to 10%, that means you have 50 companies you own 10% in.That's right.That means to hit the $4 million number, one of them has to hit $40 billion.Correct.
SPEAKER_02: So in the last 10 years, JCal, the number of exits above a billion are 300.That's it.
SPEAKER_01: Now do the number of exits above 10 billion.You can almost count them on one hand.You got Snowflake, you got Uber, DoorDash.
SPEAKER_02: Yeah, about 5 billion is like 55 in the last 10 years.So, I mean, they're incredibly rare.Very rare. And that's why it's really interesting, you know, venture sort of market.There is, you know, smaller firms that are still somewhat doing traditional, you know, if you're a hundred, you know, again, math on a hundred million, you know, a hundred million dollar fund. To do 3x net, you'll have to create total exit value of roughly 400 million.I mean, that's, you know, I can see a number of paths to doing that.You don't have to hit a billion dollar exit at all.
SPEAKER_01: Well, we could do the same math here.Let's say you on average 5% at exit.Not as much as the other firms.5% at exit.Right. If it's a billion dollars, that's 50 million.And so here, if you were trying to, you know, if you had a company that hit 5 billion and you have 5% of it, okay.You know, now we're starting to talk about, you know, a decent return there.
SPEAKER_02: Well, the median exit is like 87 million.Yeah.Even if you had a few, I mean, you know, even if you had a few of those, I could see, you know, a $100 million fund getting to a 3x net without even a billion dollar exit at all.
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Visit devsquad.com and get 10% off your engagement.That's devsquad.com. And this is the math I have learned and studied.And so let's just pull up also the yearly chart here.And then you had a question for me about portfolio construction.I have an update on that and I can get your feedback as an LP and a GP, which is, you know, one of the reasons I do this show is to, for me to get smarter and, you know, having these conversations will make you smarter.There's that crazy peak 2021.You got almost $2 trillion in exits.Yeah.Yeah.
So it was 2,000 exits and what's the dollar amount there?Where's the dollar?800 billion almost.800 billion.It's incredible.When you think about 800 billion, like, whoa.Yeah.Now, it's important for people to understand this is not the total value of the companies.This is the value of the equity owned by the venture firms.Correct.
The majority of the equity, you would think 50%, 40%, actually, maybe it's, you know, a large chunk is owned by the founders and the team.That's right.That's right.So lest anybody think, oh, there's $100 billion IPO for Airbnb or Uber.Oh, the $100 billion goes directly to these numbers.No.No. About half of it goes to these numbers in all likelihood.And then it just plummets, which is just incredible to show you what happens.We went down 90% in terms of the exit value.
The number of exits went down 25%, 2,000 to 1,400, so 30% or so.And then it's gone down even more.
SPEAKER_02: Yeah, I think the exit values are down, but I think you're right.The reason that number looks high, like higher than 2017, There's a lot of seed and pre-seed stage exits.They didn't really return a whole lot of money.
SPEAKER_01: Aquahires in some cases.And this is what people don't understand.Maybe you could explain in an aquahire the dirty little secret of those transactions.
SPEAKER_02: Yeah, definitely.A team, you quickly decide that there's no viable path and a Facebook or Meta or Google or Apple, someone acquires them just for the talent.
SPEAKER_01: And then if there was 20 million put into that company, let's say the company gets bought typically for? 17 maybe if you're lucky it might get bought for 5 million you know and you know that 5 million might get carved out 2 million to the employees 3 million to the pref staff which means whoever the latest investor was who put in 5 million gets their 3 million gets all of it everybody else gets washed out that's right And these are incredibly frustrating sometimes, but it's part of understanding what happens in venture is you got to just keep it classy, let the acquihires happen.Nobody's really getting rich.Although I do get a little perturbed sometimes.I don't know if you've seen this, and Zuckerberg was the master of this.He said at one point to Chris Saka, one of his startups, he told the founders, like, screw your investors.We'll give you guys like $5 million in equity over the next four years, and we'll give nothing to your... you know, investors.We'll give you 500K, just 5 million into the company.
They get 10% of their dollars back, but we'll just give you all the equity, which if you were the acquirer, do you want to give money to the VCs or do you want to give money to the employees?
SPEAKER_02: Yeah, motivate them to work for them.
SPEAKER_01: So I have a simple standard.When these acqui-hires happen, I just say, give us the total value of the founder buyouts and the preferred stack.Just keep it like 50-50.I don't know, something like in that range. And, you know, it's like, sometimes we'll see, you know, 4 million and 1 million.I just say maybe 3 and 2, 3 million to the founders, 2 million to the investors.Can we just keep it somewhere in the 50-50 range?Not that it matters, but I just think it's better hygiene.I agree.This is where I think...
having republicans in office not to make this political um but when republicans come back in office which seems like it's a decent possibility for anybody who's terrified by the concept of a another trump presidency i might be one of them uh like how chaotic it's going to be.The one silver lining for venture investors is M&A might open up again and they might tell Lina Khan to hit the road and hey, M&A needs to come back because this anti-capitalistic approach is really frozen the market.We need to get billion dollar to $20 billion exits with the big companies, medium-sized companies buying them.What's your thoughts on keeping the market competitive while allowing M&A.Is there any solution here?
SPEAKER_02: No, I think you're right.You know, so I think there's got to be some, I think the pendulum looks like, you know, swung too far.Like Amazon buying a robot, you know, vacuum cleaner.I don't really, I don't know what interests, consumer interests are protected by that.You're right.I think one of the, you know, Speaking about, you know, comparative advantage, you know, our country is innovation and that cycle of people starting business and businesses and then getting, you know, liquidity off of that and then doing it again and again and again.That's that flywheel.No one does it better. I think in the long run, if we lose that, that asset class, I mean, we just talked about how difficult it is to start a company, to invest in a startup and underwrite that and seeing that through all the way to the exit, it's really difficult.
And that's sort of a key driver of our growth.And if we disrupt that, I don't know that that's in the long-term best interest of our country. But I'm not saying there aren't legitimate competitive issues, but it looks like the pendulum has swung too far.
SPEAKER_01: The competitive issues were probably both manifested by a series of three acquisitions.YouTube by Google.Yep. instagram and whatsapp by meta aka facebook if you look at all three of those none of those would have occurred under lena khan right hard they would have been stopped now if you double click on those i think youtube probably would have failed i think they would have gone out of business they were unfundable they had a multi-billion dollar lizard significant chance youtube would not exist if it had not been bought Instagram and WhatsApp.Instagram bought for a billion, WhatsApp for 19 billion, I believe.So if you look at those two, I think there's a good chance that Instagram would have been worth 25 billion at IPO and today would be sitting at 500 billion, 250 to 500 billion.
SPEAKER_02: I think the distribution proved to be really more valuable in that case, both Google and Facebook's case, than the product.And you're absolutely right.To argue the other side of that, I think as a result of that, I think we have three, four, five, I think the five largest companies in the world are American.They're tech companies.And do we want that as a nation?I think we do.Yeah. Or do we want the Chinese companies to have that or American companies?For American companies, I think there has to be some balance.
It seems to me that the balance is not quite there.
SPEAKER_01: Yeah.I mean, if you look at the top 25 companies, the companies that are not American on that list by market cap, LVMH, French, Aramco, Saudi, obviously. And then you got a handful of the Alibabas and Taiwan Semiconductor, which would be Chinese or Taiwanese, you know, and I guess ByteDance is still claiming they're, claiming they're Singaporean, maybe, I don't know, where they claim to be domiciled, I think we all know.Right. So in one way, the Instagram founders, the Instagram founders and the Instagram investors would have been better served if Lena Kahn had blocked it.And I know because Roloff did that deal at Sequoia.Man, that would have been incredible.So let's start at the top here.Oh, Berkshire.I heard, I forgot about Berkshire.
Yeah.So Microsoft, Apple, Nvidia, Saudi Aramco, $2 trillion.Eli Lilly. Oh, Eli Lilly has raced up the charts because of Zampi.So number four, number nine, and number 10.Yeah, those two raced up.Yeah, Visa, Tesla, JP Morgan, yeah. It really is a challenge, actually, when you think about it, because it would have been really nice to see Instagram beating Facebook in the market now.And that would have been stopped by LinuxCon.So, you know, it goes both ways.
I think for LPs and VCs, if Uber had been bought or Airbnb had been bought... You'd be sitting here with probably a $10 billion, $20 billion exit as opposed to whatever they're trading at now, $100, $150 billion.This is the thing about being patient.I made more money on Uber even after I had sold a bunch of my shares early in secondary transactions at $30 or $40 a share.And that took 10, what, 10, 12 years?11 years, I think, from seed to exit to public.And then if you look at the public four years, I made much more money off of the last couple of years as a public company, going from 20 to $8 a share than I did in the first one.So those last doublings can be very, very material.I'm hoping that's the same for Robinhood, which I've held onto 100% of my Robinhood shares.
I'm hoping that works out. Let's talk about portfolio architecture and how you, what have you seen that works really well?And when you're evaluating this portfolio construction, what are you looking for at the seed stage series A and late stage?What is, and explain portfolio construction generally, because I think it is a evolving science slash art, maybe a bit of alchemy.
SPEAKER_02: I think it's a bit of both.
SPEAKER_01: Yeah. Yeah, so let's call it this alchemy of portfolio construction.Everybody's got their own views on it.What are your views?
SPEAKER_02: Yeah, so from where we sit, so let me first sort of address sort of the fund to funds, people that invest in funds primarily.I think what's been one thing that's sort of different, it feels different this time around, sort of overhang from Zerp is fund sizes have gotten bigger.I mean, some of them have come down a little bit, but not really. it occurs to me that there's two different products in the market today.There is the mega funds and there's sort of the smaller funds.I'd put the smaller anything under like a billion.I mean, even under a billion, there's a seed and that are smaller, but it occurs to me that they're really, at this point, they're really creative for different kind of LPs.These mega funds really are for people that are To your point earlier, as long as you're getting 500, 600 basis points on top of what an S&P 500, a 7% return, it gives them a different kind of exposure, different stage, different class of companies.And they're not really...
Nobody has said this to me directly, but my inference is that they're not really trying to do the multiples game.They're not trying to do a 3x net.It's more of an absolute dollar return as long as they're not going to lose money.And they're probably not going to underperform the S&P.They're going to be...
SPEAKER_01: So they literally might be going for that, you know, seven, eight, nine, 10%, and then hoping, hey, well, maybe I get a lottery ticket on top of it and I do 15.
SPEAKER_02: There may be, you know, a data, you know, or, you know, an Uber, you know, once in a while, and that might put them to 15% IRR, but it's really, you know, I have to guess. Now that J-Curve is back, it's going to take 10 to 12 years for the funds to resolve themselves.It's a 12% to 14% IRR game, and that may be okay for a certain class of LPs.But I think LPs are trying to figure this out.And if you're like us, we care about multiples.
SPEAKER_01: um you know we try to you know hit at least three to five x net not all of them will do um so cash in cash out i put a dollar in i want three four or five back after all the fees after all the carry expenses i give you one i got to get three back would be amazing to get four or five in 10 years 12 years whatever it was let's say 10 years five x is 18 ir yeah
SPEAKER_02: And that's hard to do just with funds.So you have to do a little bit of direct investing, sort of like I was describing earlier.You've got to put some additional money into some winners.Then you can target 18, you know, reasonable to get 18%.And that's what, you know, I think, you know, a certain class of LPs are trying to do.And because of that, I think we're focused on finding smaller managers, seed and pre-seed, where we can figure out a way to underwrite them, which is not easy.
SPEAKER_01: when we think about portfolio construction, let's go to the seed.Most seed, when I got into the business, you know, $10 million fund, 100K, 100 investments.Hope you hit a unicorn.Luckily in my first one, I did 109 names, hit four unicorns, worked out well, 5X on paper, 1.X already DPI.I think, you know, somewhere between those two numbers is where we wind up or maybe things grow.Maybe it becomes six or seven, who knows?We still got time.So let's talk about then the critique of seed funds is, hey, they don't have reserves, et cetera. We did a little analysis on my first fund for unicorns in that fund, Robin hood, superhuman density and calm.
Yeah.We looked back on it.We knew three of them were unicorns.It was just obvious.
SPEAKER_02: Like, when did you know? Series A, Series B. It was obvious that they were the winners in the portfolio.There'll be a big outcome.You don't know how big, but you know that there are going to be large companies.
SPEAKER_01: Exactly.It was very clear based upon certain signals, mainly growth of the business, actual fundamental growth of revenue and users. um with density it wasn't as clear because they were in the product it was a hardware product so they were deep in product discovery mode but you know it's pretty clear with those three we didn't place a second bet if we had placed a second bet on any one of them we'd be a 15x fund 10 15x fund if we had done two it would have been a 20 25x fund That's informed everything I do now.Same thing with my Sequoia Scouts.I did about 650K deployed, returned 120 million, hit three unicorns in about 18 investments, one every six.Never going to happen again, but got lucky.And so I guess, how do you think about how much should a GP, how much should a fund keep in reserves to make those second and third bets at the seed stage?
SPEAKER_02: Yeah, so I've talked a lot about this with our managers.One thing that I've sort of learned to appreciate in venture, you know, seed, pre-seed, doesn't matter where, is there's a number of ways to get to, there's a number of paths to get to 3 to 5x.But it's hard for me to see how you can do that if you didn't put in more money into your vendors.I mean, you know, we can debate. whether you're going to be consistently be able to identify those, you know, those winners or not.That's more probably art than science.I think, I don't know who said this, probably Adam Fisher at Bessemer.Most of the value in a company is created in the last like 18 months before exit.Yep.And, you know, some people are confident that they, you know, like in your case, you kind of, you know, you don't know how big, but you knew they were big and you knew enough.
to put more money into those companies.We intuitively think that makes sense, but there are some that are adamant that there shouldn't be any deserves at all.
SPEAKER_01: Big mistake.Big mistake.So... I think now, based on being... I'm deploying out of our fourth fund right now.Yeah.I have... architected it now, and obviously this is subject to change based on what happens in the fund, 50% in reserves is my best estimate.Now, it could be 30 or 40.It's not going to be more than 50.But I think I want to have the flexibility for 50.And so you asked how we're doing.
It's actually interesting.Now, based on portfolio construction, I have the investment team aware of the portfolio construction on the front lines, you know, running the programs found University pre seed accelerator, and then our actual accelerator. I have explained to them, hey, we need to hit 10% ownership in at least two dozen likely winners.And then we want to get to 15% ownership in five definitive winners.So I've really focused on this language, likely definitive winners.
SPEAKER_02: I think you got to have that mentality.We agree.And as you've heard me say, we like to do the same thing.We like to layer an additional capital in the winners where we're able to do that. Yeah.
SPEAKER_01: And so I had them give me the numbers.Yeah.So I'll just share them with you broad strokes here.It's kind of interesting.Because every I mean, we're deploying about a million a month, right?And we've already put about 11 million into 102 investments.So on average, it's 110 35 accelerator, those are the 125 38 founding university, those are 25 k checks 18.And it looks like about another 20 direct investment.So You know, it's kind of where I thought it would be.
But the more interesting thing I've been asking them is, how many of these did we make a second investment in?And then how many of these are getting up rounds from investors who aren't us?And I don't have that last piece of data, but I do have a number of these companies where we have ownership.I'm just looking at 1, 2, 3, 4, 5, 6, 7, 8, yeah, 9, 10.So it looks like at about 10% of the companies.Wow, very interesting.In 10% of the companies, we made a second investment. already and this is 10 and so we did and in those companies just ballpark looking at them our ownership percentages are uh 11 12 8.5 8.5 8.5 8.5 uh 11 14 and 14 and then 5 and 7 percent So, you know, we've really done a great job of getting to that 8.5 to 12% number in what I think are the likely winners.And then we would get diluted down if we don't take another pro rata to six or 7%, six or 7% on exit, a hundred million dollar exit, six or 7 million, $50 million fund.
Hey, we start returning 10% of the fund with those, what we would call singles and doubles.Yeah.
SPEAKER_02: No, I think that you got to have those, you know, base hits, you know, whatever you want to call it.Otherwise, I don't know that you can get to, you may be able to get to 2x without it, but I don't think you can get 3 to 5, you know, 4 or 5x, you know, without, you know, what you're doing.You may discover that maybe you need 50%, maybe it's 40, maybe it's 30.But, you know, I absolutely agree with you.Unless I see something different evidence to the contrary, I think that's a good strategy.
SPEAKER_01: What I like about this doubling down strategy is it makes you a better full life cycle investor.I started doing this J trading.If you go to J trading.com, I started publicly trading some equities.I had a couple of million dollars in a, like an account that was just like an index fund.And I just started to actively trade just that like one and a half, 2 million and shared the trades.I might think of it on this podcast because I wanted to be better at understanding the public market comps. Because I'm frequently faced now with exits where I personally have to make a decision, do I sell or keep my shares in Square or NewBank or DoorDash or Uber, Robinhood? So I got to make a decision personally.Do you have to become a public markets investor whether you like it?Whether you like it or not, you have to start making... And also you have to make that decision for your LPs.
Do we hold Rumble?We have shares in Rumble.Do we hold them?Do we distribute the cash?What do we do?Boom.And so this is, you know, it's not a perfect science.What do you think fund managers should do?
SPEAKER_02: In our case, you know, we want... We're paying you to be a private markets investor.So... The J-curve expectations as well as sort of what we're hiring you for is to be private market investors.We tell our managers we prefer that as soon as your lockups over, distribute the shares.And we usually do not hold it either because my mandate is not a public market.I don't have the skills to be a public market investor.So we immediately liquidate.
SPEAKER_01: Yeah, so that's, I think, the key is understanding your LP base and what they want.Yeah, I think we're in the distribute the equities if we can.It turns out distributing equities to a large number of LPs is super complicated.It's not easy.It's not easy.And in a lot of cases, you just have to sell the shares, especially if people are getting three shares of something.The cost of sending the three shares is more expensive. It is more than the cost of the or the value of the share.So it's challenging.There's no easy solutions.
This, to me, seems like the setup for what I think will be the best vintage of our lifetime, perhaps, or maybe second only to the beginning of the Zerp era boom when Uber, Airbnb, Coinbase and that cohort got funded. What do you think the next couple of years is going to look like?And how do you think about it from an LP perspective?
SPEAKER_02: Yeah, I think the reason I think this vintage and next and maybe next two to three, four years is interesting is AI seems to be real. The technology seems, the advance seems to be real.Venture industry is back to sort of normal, the right way of doing ventures, more boutique way of investing.And there's pent up demand for IPOs and M&A.The dam's got to break at some point.So there's definitely going to be liquidity coming our way. I think the only thing that I can't figure out yet is there's going to be with AI, there's going to be a period of disillusionment because people are overestimating the impact of AI in the short term.One of the things that we do that people told me that's still different as an LP is I used to write software.I grew up in a corporate setting. And I talked to a lot of CIOs and they can, you know, see those and they, you know, they have a lot of top-down pressure to do something with AI, but it's not clear.
SPEAKER_01: What should they be doing?
SPEAKER_02: What should they be doing?You know, can they measure when the CFO comes calling?Can they show ROI?Those questions are going to be asked.
SPEAKER_01: Um, do the tools work?Are they proof of concept or are they ready for prime time?Like if you look at like writing blog posts or creating video, creating images, like maybe it gets you 50% of the way there, 60, 70% of the way there, but it's not a hundred percent.Now in some pursuits, like writing a blog post, yeah, maybe 60% is really great because you can polish it.
SPEAKER_02: You know, yeah, maybe, yeah.
SPEAKER_01: But, you know, if you're making an image, it's either it's done or it's not done.Right.You can't take the image of the video 60, 70% of the way there in my experience. you might as well just start from scratch.So I think that's part of the challenge here.
SPEAKER_02: And it also seems to be that it's helping incumbents with distribution and making their products better in the short term.And there's going to be, you know, use cases where there's not any clear incumbents and we're going to find those.But the sense that I get is that we're probably two, three, you know, maybe four years away from sort of critical mass of, you know, new value being created.So that tells me that, you know, maybe there's next three, four, five vintages that might be good.So we're,
SPEAKER_01: Oh, that's actually a really interesting way to look at it is, yeah, hey, we're in this 23, 24, 25 vintage, but then there'll be a 25, 26, 27 vintage.Maybe that's the one that actually hits it.
SPEAKER_02: If you're Microsoft and NVIDIA, you know, or even snowflakes of the world, you know, you might be better positioned in the next two to three years where... In Cummins, products are a little better.Well, you know, it's interesting you say that.
SPEAKER_01: There was this expression somebody told me early in my career in the dot-com era.The first guy up the hill takes the arrows, you know, and the next guy kind of like walks over their back.There's no arrows left to be shot at you. And that actually, I watched that happen with Web2.You know, there was a cohort of delicious, my company, Weblogs Inc., Friendster, MySpace.They all kind of ran up the hill, $30 million, $100 million, $600 million exits.But Facebook and Airbnb and Uber, you know, they ran over all those carcasses and they built the truly lasting $100 billion, trillion dollar companies in the space.Yeah.Yeah.
SPEAKER_02: Yeah, if you're a seed fund and you're a $100 million seed fund and you have, I don't know, 10 companies on your portfolio and the median entry price is $25 million at seed, we'll see if those are too early and they'll be lapped by new technology, maybe by open AI, maybe a new class of companies, maybe it's time before... post the valley of disappointment before we come back.But it's definitely an interesting time to be an investor and to be deploying capital.
SPEAKER_01: This is where time dispersion is super important.Maybe you could explain this concept and what LPs expect from GPs and why GPs sometimes go too fast and they should probably pace themselves.
SPEAKER_02: Yeah, no, that's important.So especially for seed and pre-seed, it's a key point of underwriting for us How have you deployed in 2021, 22?For listeners, I think time diversification is when you deploy a fund, typically venture capital funds, you raise the money and you deploy it in about three to four year timeframe.That's been typical. in 21 and 22 that changed some of them you know deployed 12 months and you know 18 months and 24 months when you do that what you're missing is you're going to miss economic cycles you're going to miss technology maturation cycles and you're going to miss incumbents you know either failing or advancing so you're going to miss a lot of these variables that get you exposure to different class of companies And that's really important in venture for especially early stage funds.And the way we underwrite seed stage funds is, tell me what you've been doing in 21 and 22.What was your entry prices?What were questions you were asking when they raised the next round?
You're doing your prorata.Why did you write that check?On what new information?Did you get new cards revealed to you?Or were you just...
SPEAKER_01: piling on because everybody else is and those are really important questions that we're definitely asking that makes a lot of sense for me i'm just taking a note for my team uh for to look at uh how many deals we're doing per month i have the you know investment dollar and you know that can range from 500k in one month it looks like 1.2 um but on average it looks like we're doing about yeah just over a million a month no just under a million a month 750 Or so.And so I think this is really important when you have a fund.Yeah.You should look at your monthly numbers, quarterly and yearly.Now, you may happen to see this month twice as many great companies, and there's just some randomness there, and you got to make 10 investments this month, and then next month you make two.You can't kind of control these things.No.So you have to be super thoughtful about it, and you really have to be looking over... Your three year strategy, I think three years is a good number 36 months for the primary investments.
If you're doing in our case, you know, five or six a month, you know, over 36 months, you get to 150 names in the portfolio doing seven or eight, you get into 200 names in the portfolio. I think for seed stage funds, if you have an accelerator, if you can get to 200 names and then invest, you know, meaningfully in the top 20 of that, you know, it feels like one in 10 is a really good way to do it.And then it's just really a matter of communicating, right, to your boundaries.
SPEAKER_02: You'll get better and better at picking those 10 or 20, you know, as you, you know, as you go, you know, through vintages. In our portfolio, on the one extreme we have, we're a large LP in Cosla.They've done sort of quite well and they sort of stuck to what they said they'll do in terms of sectors and pacing and sort of getting the market technology cycles right.And then the other, we have a fund that nobody ever heard of here in Dallas called Dallas Venture Capital. A small $80 million fund and they did the same thing.They sort of go in at a million dollars in ARR and they work their ass off and they help them get contracts with Fortune 500 companies and they get them to $10 million and they hand it off to growth investors and they move on.
SPEAKER_00: Great thesis.
SPEAKER_02: And they've done that very disciplined entry prices, disciplined on technology sectors and, you know, deal sizes and kind of what they do on the board.And, you know, they both have credible paths to, you know, a top, you know, quartile returns.And that's kind of what we try to look at.
SPEAKER_01: I think it's really wise.And how do you think about secondary sales and clearing your positions?I have my own thoughts, hard-learned lessons here.But we've seen companies go to zero that were worth billions and just disappear overnight.FTX comes to mind, other ones come to mind.And then, you know, sometimes you have something like Airbnb where if you sold... Too early, man, if you sold your whole position, you'd feel really terrible.So how do you think about secondary and working with your GPs?Yeah, yeah.
SPEAKER_02: I've heard different LPs sort of have different opinions on this.And I have some that are adamant that they want their GPs to ride it all the way.They don't want them, you know, they don't want... I have a sort of a different opinion on that.It's hard to time the market and all that.I'll grant, you know, people that it's really hard to know when the top is.But... when you have um you know liquidity i think this podcast i think is the series is liquidity podcast so liquidity is what you know the flywheel that you know what turns to fly we you know we'll venture on that you know let's lps you know plow the money back into the ecosystem so we encourage our gps um we don't dictate how they do it but we encourage our gps to think about liquidity you know this is very common in private equity So they think about the return experience and liquidity from day one.That may not be appropriate for a C-stage investment, but they have to think about liquidity and set expectations with the founders.If you're sitting on a few companies in your portfolio, you think they're winners, but it's okay to sell 10%, 15%, 20%, take some chips off the table, create liquidity for your LPs and maybe for yourself.
And that's a great way to get to shorten the J-curve a little bit.
SPEAKER_01: I like it.I like that exact strategy.I always tell people 10%, two or three times is a great way.Then if you go public and you own 70, 80, or 90% of your original holdings, but you've paired it 10, 20, or 30%, you could have an LP who's like, oh, this 30%, you would have been at a 18X instead of a 14X fund.And you'd be like, Yeah.Or if it had gone to zero, at least we locked in the first two X for everybody.I call it idiot insurance, you know, and like, yeah, just selling 10%, 20%.If you are at, we had, you know, we, we locked in like maybe with Palm where, you know, we, we didn't have to sell, but yeah, so 10% twice.I mean, we locked in, I think a 12 or 14 X for those investors.
Yeah. You know, who are in that specific SPV and then, you know, for the fund, you know, some, some nice returns, maybe it was half the fund got returned.I can't remember.I think it was maybe half the fund got returned.
SPEAKER_02: Well, we try not to be dogmatic.I think we try not to tell our GPs how to do their jobs.I mean, as long as they're doing what, you know, what they're, what they said they'll do and their returns sort of back up, you know, you know, the promises, um, then we try not to, to be activists.We're active, but we're not activists.
SPEAKER_01: I think it's smart.You want to have a dialogue.You want to trust them.You're paying them for their ability to deploy capital and to understand those companies better than you do and return them.The only thing that happens, I do think, is sometimes people don't want to make the founders feel bad that you're selling shares.The good news now is it's almost always a situation where the founders are coming to us saying, Is it okay if we sell 10% of our positions?And we're like, sure, we'll probably pursue with you.We'll sell 10%.
SPEAKER_02: Well, as long as that's not to buy an airplane or whatever.There's an upper bound.
SPEAKER_01: You don't want to buy a house.Yeah, they want to buy a house.I always tell people 10 million or less, no problem in the Bay Area because you pay your taxes, you got six or seven million left.
SPEAKER_02: Yeah.
SPEAKER_01: It's really, you're not buying a second home or a plane.You're not even getting a jet card, so let's be realistic about it.It takes the edge off, but as crazy as it sounds to people who maybe are listening to this who don't have the ability to sell $10 million in shares in something or have $6 or $7 million in proceeds from a sale after taxes, it's still... like it's, it's not a giant number here in the Bay area or New York or LA.It's the nice number.It takes the edge off.I like taking the edge off for founders after six, seven, eight years.I think it's great.Cause then they go long and they have any insurance and they come back and they start new companies.Exactly.
Exactly.I mean, it's one of the great things.All right, Roger, this has been amazing and we'll see you all next time.Bye-bye.
