SPEAKER_04: If you're an existing shareholder, you're happy. If you're a new shareholder buying at the new inflated price, you might want to take a second look at that.
SPEAKER_00: Totally. I mean, the irony is, by the way, this has happened in many, many other industries even before this whole AI boom. I mean, go look at Klaviyo's IPO, like who's on the cap table, Shopify. Go look on the cap tables of a lot of these companies in healthcare, who's on the cap table, different hospital systems. And so, it's just being done in a different way here and now we're hearing about it versus the fact that it's been getting done behind closed doors.
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SPEAKER_04: Welcome to this week's liquidity podcast. With me today, we have a rock star lineup of guests, including Raja Dadala, the head of VC at Churchill Asset Management, a limited partner with $47 billion under management, Jason Schuman, general partner of Primary Ventures, a venture firm headquartered right here in New York City that was one of the most active investors in the New York City ecosystem. And of course, last but not least, Jason Calacanis, JCal, founder and CEO of Launch, a fund focused on the very early stage of venture. And of course, the world's greatest moderator, moderating not one, but two of the most popular podcasts in the world, all in podcasts and This Week in Startups. Gentlemen, welcome to the podcast. Thanks for having me.
SPEAKER_00: Thanks for having me.
SPEAKER_02: Yeah, thanks for having us.
SPEAKER_04: First up, we have startup valuations. What will happen to startup valuations in 2024? Here's a chart by Carta. According to Carta, the median Series A valuation has increased by roughly 17% from $38.8 million in Q3 2023 to $45.5 million in Q4. For context, peak ZERP valuations for Series A companies in Q1 2022 was $48.2 million. What this means is that Q4 valuations have reached peak ZERP pricing.
Question for Jason Shuman, what Series A multiples are you seeing in the market today and do valuations feel rich to you? I mean, I think at the end of the day, it depends on the company, right?
SPEAKER_00: And so, I always think about three different buckets of Series As. There's like what I would call the moonshots that are the high flyers. There's the predictable growers, which are your traditional B2B SaaS companies. And then finally, the ones with what I would say is like fake product market fit, but they know to sell the story. On the moonshot side, just to give you an idea, seed infrastructure deals, this is being driven by the AI boom. The median valuation of a seed deal is $39 million. And then the mean is about $56 million. But what we're seeing at the A is about a 2.1x step up there. So you are still getting paid a little bit by paying up at the seed. Meanwhile, like the predictable growth side of things, I would say like B2B SaaS companies are going for like 8 to 12x NTM versus like the less predictable product market fit companies, or the fake product market fit companies are more in that like 25 to 35 range where maybe they were up at 50 to 60 in the go go times. Jason, what are you seeing on your own?
SPEAKER_04: So yeah, an NTM next 12 months revenue, I think is what Jason is referring to there.
SPEAKER_03: Candidly, what people are calling a series A today is really like, feels more like a series B evaluation and seed feels like the old series A and then precedes seeds like the new seed. So every all these names have kind of moved down a bit. But I do like Jason's framing there of, you know, those three different buckets. I my guess is that these Carter numbers and they don't represent the entire world of startups, obviously. I think what we're seeing is these large language model series A's and some of these moonshot series A's are kind of setting these numbers off a little bit and then large funds want to put in $10 million $8 million, they want to hit 20% ownership because they're a large fund. So therefore, if founders only want to dilute 15% 20% in the round, it's got to be five times the $8 million, five times the $10 million. I'm not sure what the number was there on the average dollar amount was a 10 million was the average dollar amount for the series A,
SPEAKER_04: the average dollar amount was 13.9 million in terms of the valuation. We don't have the average dollar amount put in, but I'm just gonna pick a number 8
SPEAKER_03: million right in the series A 10 million the series A. So if they want to buy 20%, it's got to be you know, a 30 it's got to be a $40 million pre $50 million post something in that general direction. Founders pretty sensitive to this. So and they're doing more with less. So these numbers, I don't buy them exactly the seed stage numbers, I do buy them. That does seem on target $10 million seed rounds $15 million seed rounds raising $3 million. And I think that's where the value is. I think the series is it's very hard for investors to actually, you know, make money in this. And I think it's going to be really hard for people to make money investing in companies that have no traction, that are commanding a $50 million post. I think this is going to be a bad vintage for those investors.
I think the good vintage is hitting the seed round or the pre seed round. And Raja, you get to invest you have the purview of investing in pre seed seed series
SPEAKER_04: A. Where do you see alpha today?
SPEAKER_02: Yeah, just to tack on Jason's point on the series evaluations, I think there's probably a lot of distortion in this data. There's AI startups and what we're seeing in our portfolio managers, and we've done on occasional sort of, you know, a one or a plus direct investment ourselves. What we're seeing is the entry criteria certainly has changed. I think companies that we've seen today series A in our portfolio, solid product market fit. It's not fake product market fit and forward revenue multiples. We've seen as low as four and we've seen as high as 12. But we haven't seen or at least the managers that we have in our book are not doing, you know, 15, 16 times forward revenue. And they did the seed and pre seed and A and A one and seed. Except this is just a lot of noise in the data. But I think it's clear that the entry criteria definitely has changed to more realistic, more real. I think that is the the key.
SPEAKER_03: Raja is the soberness at which people are evaluating these and looking at the valuations is not in these numbers. I don't believe. And then even looking at, you know, the forward revenue versus the previous revenue, we're we're looking at, hey, what did you make the last three months and we'll average it. Okay. So you're a SaaS business.
SPEAKER_03: You made on average seventy five K each of the last three months. Let's have a discussion about the last three months, not your projections for next year. What will take your projections for next year? But let's look at the average last three months because it might be spiky. You may have signed a big client, lost a big client. Somebody had layoffs. They cut a bunch of SaaS products. Let's look at that average and let's talk about what you're going to do in Q1, Q2, Q3 and have a thoughtful discussion. Then what you did in Q3 and Q4 and how that relates and what changes are you making. And I think that's the sobriety that the market needed as opposed to just projections. Here's our two year projection. And then it's a competition between, you know, new funds with too much capital, you know,
trying to win a deal. And what are you winning? You know, in that case, if you're a venture capitalist, you're winning the ability to overpay massively and not make a thoughtful bet. So I think the sobriety is there. And I think VCs are not differentiating themselves at that series A if they're if they don't have that sober discussion in any entrepreneur who's raising a series A right now is probably having with the exception of the it seems like AI people are given an exception. And I don't know how long that's going to last, because I do think you're
going to start to see people expect to see revenue and expect to see traction. And so I think this AI party is coming to an end this year because you might see these large language models not really compete or not make any money. They look like commodities, Jason, I don't you know, Jake, you know, they're turning
SPEAKER_02: into more like a cloud, you know, provider sort of commodity type of maybe two or three oligopoly of four or three services. And that's why I think it's it's really hard to see if those valuations will last.
SPEAKER_03: That's a great point, by the way, Roger just made just today as we're taping this, you got, you know, Zuckerberg saying I'm putting out open source models, I want to make an open source AGI. What does that do to people who invested at these massive valuations for these language models? And then you have Falcon going on in the UAE, and that's going to be available all these language models, it seems like those bets. People just invested in a bunch of storage companies. Yeah. And does anybody care? Which storage
SPEAKER_03: company they use? Yeah, it's definitely great for Nvidia picks and shovels are going to
SPEAKER_03:
absolutely take that venture money and you know, bank the revenue. I just don't know about anybody else.
SPEAKER_00: Do you think though, if you even take AI out of it, there's really two things that are going to prop up prices at the end of the day. One is you have a lot of young VCs that have been not doing deals over the last couple of years that are being given checkbooks by multi stage firms, and they're propping up seed prices. And then Jake, you mentioned it, but there are a lot of new funds that raise capital. And there are also a lot of funds that raised a lot more capital. And now all the investors are specialized at those firms. And if you're a specialist at a firm, and you want to invest in the asset, you're
going to make sure that you're going to pay whatever price you need to to win that deal. And I feel like that is ultimately pushing up things across every sector, even outside of AI. Yeah, it's interesting. Inside, I think there are sector specific people, they bet their
SPEAKER_03: reputations on it, they raised the fund based on it, and now they're going to deploy capital, but you have to be aware of the game on the field, you know, and these companies eventually
are going to be, as they say, the market is a weighing mechanism, like we're going to weigh things. And the weight is determined by revenue, and then eventually earnings.
So having invested in Uber in the early days, you know, people love the growth, they were super excited about it. And now Dara is being weighed, what are the earnings? What's the
free cash flow? How many shares are you buying back every quarter? That's the story that Wall Street eventually gets to. And so the disconnect between private markets, public markets, it's all starting to, I think, get cleaned up, but we still have some cleaning to do.
SPEAKER_00: It's his East Coast personality coming out, by the way.
SPEAKER_03: I, you know, I invested at comm and Uber at $5 million valuations. And so you know, I look at thumbtack data stacks, um, Uber, all those initial investments I made, they were
at five or $6 million valuations. Now, of course, the world's different. It's whatever 1415 years later, so maybe they should be at 10 or 15. But even still, I have a hard time believing people are going to be able to make money in their portfolios investing in companies without product market fit at a $50 million post. I just don't see it happening.
You could get lucky, but I don't think it's a great investment strategy if I'm being candid.
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SPEAKER_04: in the early stage, everything is a competition for dollars is the way I look at it as a fund
SPEAKER_03: manager. So you are going to eventually have to make deals, right, you're in the business
of investing, you have to deploy the capital as a venture fund manager over some period of reasonable time, three, four years, or you have to give it back. So if that's the
case, you're going to look at your deal flow. And you're going to make the best most thoughtful
decisions. If your deal flow is very high, which mine has gotten to in the second decade, you can make really thoughtful choices. And if somebody wants an extraordinary price, well, if it's an extraordinary team with an extraordinary product, and extraordinary traction and product velocity, you can you can pay up, it's not a problem. But at the early stage, we'll see people who want to come to our accelerator, or want to do you know, a six to $12 million seed round, and then somebody else will have less traction and they want to do a $30 million round. So we'll look at that and then we'll have an internal discussion.
Should we do three other deals that we have on our plate that are at the $12 million valuation? Or should we do this $36 million deal? And it's pretty easy to say to yourself, well, three shots on goal as an investor at 12 million each, all things being the same. And then
we'll just tell somebody, hey, we want to see you. You don't want to see one more year of traction. And let's talk in a year. Many of those deals, I'd say most of them come back, David. And they have the same valuation, or they didn't hit their targets. And so,
SPEAKER_02: in that sense, are you in your world? Are you seeing a seed stage? Are you seeing? So demand vastly outstripped supply at this point demand of per dollars? It's a great question.
SPEAKER_03:
Certainly is the case in the late stage. Growth, you know, you see D&E is certainly is the case.
SPEAKER_02: It's hard to tell. seed stage,
SPEAKER_03: if you mean the demand for dollars. Yeah. Is greater than the supply of dollars. Yeah.
Yeah, I think that's the case. Yeah, people are trying to raise rounds and unable to raise rounds.
SPEAKER_02:
In that case, like, you know, picking the skill of like picking becomes probably more
SPEAKER_02: important in this environment. Right?
SPEAKER_03: I am obsessed with making great decisions at the you know, when you were on our fourth fund, not counting when it was a scout, so arguably, it's our fifth fund. But the first two funds were 10 and $11 million for us. So they were very tiny. They were like, sort of my part time fund, it was just me making choices based on my internal network. But
SPEAKER_03: once you have a big network, and then you have a big team, we have 21 people, decision making becomes a critical, critical part of this process. So you have the deal flow, how can you make a really thoughtful decision? Right? And how do you make those decisions when you're not under time pressure anymore? That's the other thing that's absolutely fantastic about investing right now is there's no time pressure, you know, if you don't get into around, companies going to be raising in six months or 12 months, or if you made them an offer, let's say they were closing quickly. And it's 612 months from now, and you say, Oh, wow, you hit some targets, hey, we'll step you up 20% of the valuation, would you take another half million? They'd be like, Yeah, founders are realists now. So I think
it's a lot healthier in the market that people take the time, I don't know what you're seeing, Jason. Yeah, I think the time for a deal to close, but it seems like it's three months right
now, two or three months for deals to close. It's definitely extended, it's definitely extended.
SPEAKER_00: And candidly, we look at that as an opportunity for us. And the reason why is, you know, we're concentrated investors, we're writing three to four checks a year per partner. And you know, we go very deep into markets, because, you know, we agree decision making is incredibly important. And so ideally, you're getting a deal in and you're moving through a process because you're
bringing a prepared mind into those meetings and can make a decision in two weeks. And if you can, while also getting the chance to get to know the founder very well, we're already have gotten to know the founder very well, then you can ideally win the deal at a very high rate north of 90% annually. But I find that candidly that a lot of investors now, nobody knows what the pace is anymore. Whereas like the go go times, everyone was like at max speed. And so now it's like all sorts of weird of managing expectations with the founders of how long it will take to actually raise around how many meetings? How many meetings Jason?
SPEAKER_00: How many meetings? How many meetings now would you say is your average or median?
SPEAKER_03:
So mean? Yes. Five meetings and a hop on about four sales calls where I introduced the company to
SPEAKER_00: central customer and I get to listen to those nine calls. Wow, that is incredibly thought that's great. That's great.
SPEAKER_00:
Trying to suck up as much time as possible while also helping them grow their business. You know,
SPEAKER_03: I love that hack. Tell us more about that one. The hack of being on a sales call with them. Wow.
SPEAKER_00: I think at the end of the day, you know, it's it's pretty funny that I that you end up meeting a founder, you hear them pitch, and then you call customers, you call potential customers, right? But you never like get to hear them actually do the pitch themselves. And so when you do, you don't actually know like, what are the questions that are popping up the new potential customer? And how are they reacting? Does it take them two minutes to react and then like fall in love with the business and the product? Or does it take them 20 minutes and like, and that's a huge, huge difference in terms of finding product market fit. And then if you want to win a deal at seed against some of the best investors in the world, I think you need to show value out of the gates. And that's just one way to do it. That's really easy for us, because we've just built this massive customer pipeline across all the different sectors now, Jason, what do you believe is is winning in today's markets, you have this kind of relatively
SPEAKER_04: stable seed valuations that have gone on over the last couple of years, and you have this increase in Series A pricing, what is leading to VCs winning the hottest deals in today's market?
SPEAKER_00: I think it's very, very simple. It's who can build the best connection with the founder, and who can end up adding the most amount of value at the end of the day. You know, if you're net net, you know, the way we look at it, and Jacob, I think you were saying some really interesting stuff earlier, you know, we're doing four deals, we're incubating companies to bring our average entry price down. But then if whether you're doing a deal at 14, or you're doing a deal at 20, it's not that big of a difference for us, you know, we'd rather just make sure we get our ownership there. So during the process, it's showing how we can add value and go to market, strategic finance, and then like the people side of things. And we have 35 operators here at our offices in New York that work with each one of the portfolio companies. It's an expensive operation, but that's how we end up trying to go out there and win deals.
SPEAKER_02: Jason, who are you competing these days for deals or ownership? Is it the, you know, multi stage firms going earlier? You know, is it super angels like, you know, J Cal circa 20? You know, and who are you competing with?
SPEAKER_00: Only deals we've lost over the last 18 months have been the multi stage funds. Speaking of multi stage funds, Raja, you alluded to the series A and beyond, it's a stage that has
SPEAKER_04: really turned around at its lowest series E and beyond had a median valuation of $251 million in Q1 2023. And I've since increased to a median 708 valuation in Q4, representing 182% increase in valuation over the course of just one year. Raja, do you think this is a response to previous over correction early 2023? Or do you think public markets are really dragging these valuations higher?
SPEAKER_02: I you know, it's interesting you say you know, the correction, I don't think it was an over correction. I was just looking at this new report, the pitch book and NVCA put out median exit size for IPO. This is just IPO and there's data for acquisitions and others. It's like $110 million.
That's the median exit. And if you look at that chart, you know, last year, the median series E
was $250 million. And then this quarter, its median, you know, is $750. But I'm still trying to find data, but there aren't many $2 to $3 billion exits there just aren't. So it still feels high to me. You know, the other thing that I, you know, trying to figure out is who's doing these series E's, cost-alwards or not. And Corporate Venture, you know, X, Microsoft and Nvidia put that aside.
Corporate Venture is down like 10-year low. And so I'm trying to figure out who's doing these
rounds and then what is their underwriting timeframe and what do they expect in terms of multiples. I can't imagine, you know, series E investor not expecting at least 4X or at least underwrite for, you know, 4 to 5X and a 3 to 5 year hold. And that's about a 22% IRR. I have to believe that that's challenging for a typical outcome if you're doing it at 750.
I don't know what you got other JCal and Jason, how you guys feel about that? It's important segue, I think because if you look a lot of those late stage rounds were in fact,
SPEAKER_03: he alluded to it being done. I think maybe David, you could key up the story that Bill Gurley has been talking about of this massive investment because these numbers in the abstract are very confusing. As you can see here, two GPS and LPS because they don't match the game on the field. So what's with the distortion here? Perhaps this blog post and Bill Gurley tweet about the
SPEAKER_03: the Nvidia's of the world and the Microsoft's of the world. Doing all this investing for credits, etc. might be part of the challenge and the numbers. Are you still using your personal
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SPEAKER_04: here. Apparently there's a new VC in town and his name is Ming, Microsoft, Amazon, Nvidia and Google highlighted VC investments from Microsoft, Amazon, Nvidia and Google have ballooned from only 1% in 2022 to 8% of the entire VC market in 2023. So an eight x increase. If you look at rounds, individually, there's been massive rounds like open ais $10 billion around led by Microsoft in anthropics $4 billion around led by Amazon, which has had ripple effects question for the group. What do you think about this new VC mang entering the space?
SPEAKER_03: The definition of strategic right there coming in here for strategic reasons. It doesn't have to do with return on investment. Microsoft, Amazon, and Nvidia are not looking at these investments the way LPS and GPS are looking at that they don't not care about the multiple on invested capital.
SPEAKER_03: They care about being disrupted by a startup that comes in and, you know, yeah, you know, eats their cheese. So they're looking for option value here is really Nvidia volume wise and
SPEAKER_02: Microsoft. And it's really option value, but that should be completely distorting the averages. It's a very temporary, you know, hopefully it's a temporary trend. Pretty amazing that I mean, I absolutely love it. When you think about venture investing,
SPEAKER_00: it's like, how do you create asymmetric upside. And these guys can create a lot of asymmetric upside and be kingmakers. And at the same time, we're undergoing one of the biggest revolutions or the biggest revolution in my professional career. And like, they don't really know who the winner is going to be. So why don't we just deploy a lot of capital and do a lot of partnerships with companies and see where it goes and index it all. Now it's like a much different scale in terms of check size and credits and so on and so forth, but it's additive to their business, and they'll be able to catch the returns from space. We do a little bit of direct investing
SPEAKER_02: alongside our GPS. If there is a company that's in the vicinity of big strategic investor going in, I stay out. I don't know how to make sense of it. I don't know how to underwrite it. I don't know how to think about the valuation. I just don't know how to even look at it. So I just stay out.
SPEAKER_03: This is one of the problems with strategic investing, I think is because they're not invest they're investing because of the optionality and to protect their core business. The distortion is so great that whoever the angel investors to seed investors, the series A investors or as B investors, all of those people, the co investing LPs, perhaps they now are left with this monstrosity, this franken startup, that if it goes public, well, now it's competing against
Microsoft. If it goes public now, maybe it's competing, competing against the people who gave it strategic money. And then maybe they don't want it pursuing certain opportunities and going into certain markets. And this is why strategic capital is so dangerous for founders. It's incredible to get it. It's it the high valuations are lowering the dollar sizes here are extraordinary. But then
what happens when you have somebody on your board, you know, like Amazon, and the the founding team says, you know what, here's an interesting idea. I have something that's disruptive of AWS.
What are they going to do? Now, you've got, you know, this serious conflict of interest,
and that's eventually what happens. And then you're the early stage investor. valuations gone sky high. How does a single public How does it have an exit? And we've, you know, you've seen this before with strategics, where it can get really challenging and difficult, especially with these big companies. So I think it's, it's going to end in tears in many cases. The good news is, I think, to Jason's point, right, you were talking about how extraordinary it is to be alive at this time. It's kind of interesting that Microsoft is doing interesting things with these cash awards, you know, they're just putting massive amounts of cash to work, which is kind of inspiring in a way
that they're taking advantage of this opportunity. I was gonna ask you guys, if you guys are
SPEAKER_00: shareholders of man, are you happy about this, that they're doing this? Or like, I was looking at it from that perspective. And I'm like, that sounds good to me. Of course, I think Microsoft,
SPEAKER_02: I'm happy. I don't know that in video, in video, it just seems I just don't know how to think about that company. And the future prospects with everybody doing their own silicon, I just don't know how to, but if I'm Microsoft, I think Satya and the team there, I think they're just really, just I would be happy if I'm Microsoft's shareholder. The interesting part about
SPEAKER_03: this that Bill Gurley was bringing up, which I think we should talk about as well, is how much of this is round tripping. And I'll define round tripping in a minute.
How much is round tripping of either credits for Azure in Microsoft case, Microsoft's case, or buying silicon from Nvidia? So Nvidia puts in, you know, whatever, hundreds of millions of
dollars, and then the company was an interesting core, we've is an interesting case. Yeah. Yeah.
SPEAKER_03:
So explain it. I think it's like, this is really worth and round tripping for people who don't understand is when one person invest money, and then the other person buy services from them. So
the money is round tripping the SEC and other Department of Justice, they've taken action against companies in the past for doing this, because it can look like you're propping up, painting the tape, etc. No, that's a good core core weave. I think, you know, it's, you know,
SPEAKER_02: they buy processors from Nvidia, and then they resell them. And they're a reseller of core use services. And it's in there, an equity investor. So where are they counting the sales? Are they counting, you know, for Nvidia? Are they counting for a core weave? And how are they valuing their investment? You know, I tried to make sense of it, I couldn't. So even to explain that I couldn't. So it's a really strange, strange case. This is ultimately just old school financial
SPEAKER_04: engineering, you give somebody 40 million, they buy 20 million worth of chips. And if you're trading at a multiple on your stock, whether it's a 7x or 10x, you get to capture all that upside while also having the asymmetric equity investment in that company, if that company ends up actually becoming like an open AI and then they don't think equity value is double counted.
SPEAKER_02:
Yeah, see, your core weaves evaluation. And then Nvidia's public valuation is double counting going on and definitely an evaluation. You know, I don't know enough to say the sales are double counted. I'm reasonably certain the valuation is double counted in two companies.
SPEAKER_04: So I think to your point, Jason, if you're an existing shareholder, you're happy if you're a new shareholder buying at the new inflated price, you might want to take a second look at that.
SPEAKER_00: Totally. I mean, the irony is, by the way, this has happened in many, many other industries, even before this whole AI boom. I mean, go look at Klaviyo's IPO, like who's on the cap table, Shopify, you know, go look on the cap tables of a lot of these companies in healthcare, who's on the cap table, different hospital systems. And so like, it's just being done in a different way here. And now we're hearing about it versus the fact that it's been getting done by and closed doors. We have an expression in the industry, no conflict, no interest. And so yeah,
SPEAKER_03:
you know, it's conflicted. So that makes it super interesting. You just can't get too cute, or else regulators get involved. And they're like, Hey, can you explain this to me? And I remember early in my career, an attorney was speaking at a conference I was at and just said, the appearance of impropriety is impropriety, as far as he was concerned. And so you once it looks inappropriate,
it is inappropriate. That was his, you know, message to folks, this looks inappropriate, in some cases, therefore, it is inappropriate, it would be much cleaner if the investing was done by professional investors. And then people made independent decisions of what they would do with that those dollars as opposed to the round tripping. And you can just type in AOL round
tripping time one around tripping AOL did this in the 90s sales teams would sell a startup on taking a $50 million investment from AOL, that company would then buy 30 or 40, maybe maybe even $60 million worth of advertising over the next seven years to be the default portal page for music for
women for whatever vertical topic editorially, you know, they were involved in and there was a massive fine. And I think some people even went to jail for a short period of time for doing this kind of stuff. So when your name is on that insertion order, and you've done the round
tripping thing, and then you get a commission on it, man, this stuff can get really, really gnarly really quick, because you also have people with equity compensation. So you're the CEO of Company A that made the investment and your equity went up to Jason's point, your equity just went up. And
then Roger was like, hey, well, wait, equity in both companies went up. And then the management team gets equity bonuses for hitting revenue targets. And this was a contributor to the
revenue target. So let's say the entire management team, if they hit 1 billion in sales, gets this incredible bonus. And then this investment with the round trip got you over the hurdle.
Really messy. And so people got to keep an eye on this one.
SPEAKER_02: But it's definitely sort of the AI enclave. I think as you talked about J Cal and other podcasts like this, there's just lots of weird stuff going on in the AI enclave.
SPEAKER_03: Because people don't know where the value is going to reside, I think in some cases, there's so much value that's obviously going to be created. So if a lot of value is going to be created, people don't know it's splashy, cashy, I think, right now, right now, startups
SPEAKER_03:
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SPEAKER_02: you know, alpha, I don't know that we know is this is sort of a six to 12, you know, year alpha, we won't see that, you know, until you know, eight to 12 years. So what here, but I'll tell you where our dollars are currently 60% of our LP dollars are currently in series A through D. And but in
terms of actual number of positions, these the opposite 60% are in pre C and C sort of smaller funds. So that's kind of how you know, our portfolio looks like currently, there's a rush
SPEAKER_03: right now to get to seed and pre seed, it's crazy seed is kind of series A. Yeah, and so series A has always been the coveted spot, you got to just enough traction to know it's, you know, it's, it's, it's just past, you know, the the product market fit phase, but not where the valuation is obvious to everybody. It's like this very sweet spot. We used to call it series A and benchmark used to do it. Now it's really seed and benchmark. I think it still was the early stage, right? That
SPEAKER_02:
was the early stage. And then in terms of you know, being Jake house point, like sobriety is back to series A, that is, you know, some of the firms, not all of them. But you know, which,
SPEAKER_02: which makes it David, if I have to pick one entry point, that's probably where the, you know, on a risk adjusted basis, the alpha is it's probably series A, you have a much larger portfolio at the pre seed and seed and a much more concentrated series A,
SPEAKER_04: are they fundamentally different asset classes to NLP?
SPEAKER_02: I think they are, because, you know, see, you know, see and pre C, there's a five to 8%, you know, premium that's available as an LP, you know, you, you know, historically that's been true. So as an LP, it's tempting to put more dollars there, especially in the period that we're in where sobriety is back that are processed, you know, to Jason's point, you know, you know, more meetings, but that's a, that's a really fraught area for LPs, especially large institutions, because you have to see we've seen 250 firms last year, and we made what 12, 115 bets, that's a really hard thing to do. Lots of institutions just don't have the the patience or the time or the resources to do it. So speaking of asset classes, that that may or
SPEAKER_04: may not have alpha, let's talk about secondaries. Lexington partners has raised a new massive Secondaries Fund, the fund Lexington Capital Partners 10, which initially had a fundraising target of 15 billion raised a whopping $22.7 billion, significantly up from their 2020 vintage of $14 billion. It's reported that already 40% of the capital has been deployed across 50 deals. Other firms are also following suit. Pine Grove Capital Partners, which is a joint venture between Brookfield and Sequoia, as well as StepStone are also raising multi-billion dollar secondary funds. Based on a recent SEC filing, it's reported that StepStone has already raised 1.25 billion. Raja, I know you've seen a lot of opportunities in the secondary space. What are you seeing today?
SPEAKER_02: I've looked at secondary funds, a lot of them, and I've turned them all down, David. The reason is, you know, a lot of them, most of them, not all of them, but most of them, the strategy is basically price arbitrage. It's not that interesting to me, that part of, you know, if it's the secondaries, it's a way to sort of, you love the company, it's a way to get in the door and then increase ownership. And there's some that do that and we're an LP in a fund that does that. But if your secondary strategy is strictly, you know, you think there's this massive arbitrage in price, I'm a little skeptical that that will work and warrants tens of billions of dollars of capital. I can't believe that there are that many quality distressed assets. I just can't, you know,
I just, you know, I try to understand it. I've asked them to explain it to me and they're not able to convince me. I had one or two people who know our book of business from, you know,
SPEAKER_03: our first funds, so, you know, kind of knock on the door, hey, can we talk about doing, I think they called it a strip and they, you know, hey, we'll, we'll look at your two funds
as the GP. We'll get you some liquidity. So as, but one example, our first fund, I think is like 4.9 or five X on paper, we've distributed one point X and they're like, Hey, we can get you to that three X. That would look really good to GPS in this kind of market. I'm sorry. To LPs in this kind of market. Can we, can we get a little strip there? And we know there are some cool assets in there, whatever they've done the math. And so, you know, I did look at it. It didn't go very deep because I looked at it and said, well, you know, this is a small fund. These are me and my friends money. I have faith in the names. Yes. The market came apart for two years and we, you know, post-serp and COVID everything went crazy, but we can hold on. We could just communicate to
SPEAKER_03: our LPs. Yes. We think things are undervalued. I had somebody email me just last night. Hey, can you tell me about these three names? And I was like, I'm on the board of this company. I'm in touch with these two founders. We still believe in these names. Yes. They, their peak valuation in two out of three cases is definitely lower, but we have insight into those companies and we
think they're great. So why would we give that opportunity to somebody else and go through the point of a transaction? We'd we'd rather just, you know, I'll pick up on that. I think we get
SPEAKER_02: occasional calls from our GPs. Hey, you know, we have this opportunity to sort of bank some when it was like a three to four to five X when that's a minority, but like they're selling 10 to 20% of the position, not like 80% of the position at 40% discount. I think that's a valid, you know, creating liquidity is kind of what makes the system sort of, you know, the flywheel turned. So if you have the opportunity to create a three X, you know, outcome for the fund by selling 20%, but that's not a distressed sort of sale. That's more of an opportunistic way to create DPI, which is I think about to do. And we've sold a couple where we're, you know, we're sitting on a, you know, a seven X net, and it's a nice, you know, four to five year hold. And, you know, my capital provider likes cash, especially with liquidity being delayed in the market. But that's not a, we're not selling under duress is sort of a more of an offensive thing.
SPEAKER_00: Jake out took the words out of my mouth, because I think that, you know, there was a lot of funds that started to get raised in the 2015 to 2017 era, that now are sitting on a lot of big marks, and they need to come back to market. And if you're a secondary fund, and you're looking at all these funds, and you try to find the funds that have the most diversification, you know, for instance, like our first fund here primary, I think it'll be about eight unicorns out of 24 companies, like, if you're going to go do a strip sale, that's the type of fun that you want to go do it at. Because like, you know, that there's going to be some companies that don't pan out, there'll be some companies that do pan out. And like, it's easier for you as an LP to underwrite if you're going to buy that out. Versus I think it's very, very scary when you're looking at some of these funds that are, you know, I mean, you look at the average seed stage fund, what 8% of their deals become, you know, north of 10x type returns, and hopefully that's going to pay for everything. But all of a sudden, you see companies like, you know, convoy and a number of others that go out of business just like that overnight, and all of your returns are gone. So I do think that managing liquidity is an incredibly important thing that some firms don't well. It's an active activity. It's not a passive activity. So I think every GPD should be,
SPEAKER_02: you know, trying to create liquidity.
SPEAKER_04:
Jason Schuman, how has primary managed liquidity? What's your operating principle?
SPEAKER_00: I mean, anytime that we're constantly thinking about it, and we will sell shares of companies, when it starts to get to the point where it's obviously a fund returner, for instance, we have a couple of positions that were north of that first one was 60 million. So we took off, call it 10 to 20%. We left the remaining 80% riding, that got us a half a turn of the fund or a full turn of the fund. And then, you know, you still have all the upside in the world. But, you know, whenever I talk to LPs, by the way, they say one of the most impressive things about Union Square is like Fred Wilson's ability to get out of positions as much as it is to get into positions. Because if you look at the best venture funds in like your any vintage year, the top 5% is never much further north than six x. So if you're at a six x, maybe you should start considering selling out at that point.
SPEAKER_03: Yeah, I think it's really wise. And you know, Fred and Jerry Colonna, when they were running Union Square Ventures back in the day, or sorry, Flatiron Partners, the precursor, you know, where they had a bunch of investments like geo cities and a couple of other ones that did collapse. And I think they got scarred early on by some of those. And then you look at like a firm like benchmark, I think does a good job as well. When you look at we work, which funds made money on we work like that thing went down in a blaze of glory, as we all know, and they seem to
have sold their position, you know, at a couple of billion dollars, and it always looks smart. So just at launch, when we get these offers, we sell 10%, 20% on the way out, maybe once or twice.
And, you know, then you have the 80% in play. And on a personal basis, I've told you this David
before, like, I sold some of my shares back to Uber at $32 a share, years before they went public, I sold a bunch to Mossad, I think a 40 or so I don't remember what his secondary was for our
shares. And then I held the rest. And here we are today it hit a record of 65. Yeah, there's not a signaling risk. If you're a small fund, and you're, you know, you're not,
SPEAKER_02: you know, the lead, you know, series B investors selling half would be a signaling risk, but a seed investor selling 20% is not a signal. I think this is why also, Roger, you tell me if I'm right,
SPEAKER_03:
lps are interested in seed funds, because they do have this chance to hit the early liquidity. Correct. Whereas like, if you're a later stage fund or a series a fund, well, you already paid 200 million. Now the company's worth 600. Like it doesn't to Jason's point, give me that full turn
SPEAKER_03: of funds to five x in a smaller fund. Definitely. Yeah, I always find it funny, though, especially,
SPEAKER_00: you know, when I first got into venture, and you know, being in New York, you hear this, like, West Coast mentality of rider winners, I think Jay, it's in your, in your intro, right? Let your winners ride. And like, you know, you go through one down market, by the way, that completely changes. Or you talk to one hedge fund manager in New York City. And that also completely changes because managing risk is just super important. And too many VCs are good at picking companies, but they're not good at getting out of that.
SPEAKER_03: Yeah, let your winners ride with a caveat of salt 20% 30% on the way up. You know, like, if you
think about if, you know, people who were in Facebook, or Google, you know, I have a lot of friends who were early Facebook, early Google, many of them liquidated their entire positions,
SPEAKER_03: you know, and if you liquidated your Google or your Facebook or your test that very early positions, man, that smarts that smarts for a while that stings, right. And I'm always a fan of maybe 50% keep 50% and sell 50% you said that you're never selling your Uber shares,
SPEAKER_02: you know, I don't think I'm ever going to sell the ones I have remaining because I believe it's
SPEAKER_03: a trillion dollar company. I believe in network effects. I believe in the management. I believe in the profitability of it. It's a verb right now. And so I feel it's kind of like destined to be like Amazon or Apple or some of those companies. And you know, if it's going to be the next Amazon or Apple, I'm going to be alive for hopefully 30 or 40 more years. Like, what's the point of selling what I have left, I could just ride it forever. Yeah, and that's worked. Okay. I mean, it is a
SPEAKER_04:
SPEAKER_03: little stomach. I will say, you know, when it hit 15 $16 a share, man, my stomach was like,
you know, you to because that was at, you know, a certain point, the majority of my net worth, I did diversify some of it. But you know, that that was, that's a gut check. What was that for you?
SPEAKER_04: J cal 4000 x? Is that the correct multiple? I mean, depending on where you tip it, you know,
SPEAKER_03: if you tip it today, it'd be more than 5000 x, right. So I always tell my LP is the same thing. My returns are only going down from here. The chances of me hitting another 5000 x are low.
But yeah, you know, I did change my strategy to try to own 10% of the winners rather than 10 basis points. You know, so if you, you know, adjust your approach, your math is different,
SPEAKER_02:
your portfolio math is different now, we're your stage of your life. Yes. Yeah. And right now,
SPEAKER_03: like I'm trying to my strategy is have enough surface area per fund, which is 300 of the accelerator type companies to have 20 of those become unicorns or something really meaningful, hundreds of millions of dollars, and then be able to plow half the funds dollars into the top 10 names, right? So they're spraying prey as a portfolio strategy, then there's concentrated and trying to do both of those things in the same fund is very hard for people to understand. And that's the thing I'm trying to do, you know, and we'll see as a strategy, if I'm successful, we'll know in the next couple of years, you almost have an entire portfolio that an LP would have,
SPEAKER_04: if you look at Rogers portfolio, you have how many 20 funds with 30 managers, 30 manage.
SPEAKER_04: So you're not investing as a single fund, you're investing as a portfolio, tell me about how that changes your calculus. So our approach to the portfolio is we started like, earlier,
SPEAKER_02: you alluded to, we never thought about it that way. But it's true, we think about seed and pre seed in sort of a separate, you know, asset class, and then a through to our my focus is pre seed through D, and that's as late as we will go, we sort of have this barbell strategy where A through D is these five, six core, you know, reputable multi stage firms out of the, I don't know, 20 or 25, let's say the ones that kept their fund sizes somewhat, you know, manageable, somewhat exercised price discipline over the last six, seven years. Generalists where they have, we have a diversified sector exposure. That's one part of the sort of the barbell. And the other part is sort of pre seed and seed. And the way we think about that is these are a lot of small 25 to $85 million funds, where they have some specific network or expertise or value, that they're able to get into these, you know, these syndicates, and then have good graduation rates. And then layer an additional capital on top of that sort of inflection point series B, you know, late A or B or C at, you know, lower hold periods and better economics. That's kind of how we think about our portfolio. And Jake, how you you alluded a little bit to your
SPEAKER_04: portfolio construction. You have 300 at the early stage, how do you pick which which companies to follow on? Yeah, this is something I've hard fought and learn over 10 years, I think, and also
SPEAKER_03: just talking to LPS, because really, the fourth fund is the first time I've met with a lot of LPS, I think people are, GPS or softies, right, we love founders, we want to be supportive. And it's very
hard to communicate with your portfolio and say, we don't do bridge rounds, we don't do, you know,
we don't expand our position, you know, except in these circumstances. And in my early years,
as an investor, I too was a softy, right? And I would give token investments, I want to support the round signaling. So you know, we have a portfolio company, they've worked really hard, but they don't have escape velocity yet, right? It's not a hockey stick. But we're going to put
an extra 50k in, we want to be supportive of the founder, we want to put an extra 100k in right.
And you know what, that next hundred k could have been another accelerator company could be actually a new bed. So this bed has proven it's going sideways. And we didn't make a new bed. Was that the most capital efficient thing to do? Obviously not, or probably not? Was it the kind thing to do?
Did it make you feel good as a GP? Yes. And so we've told our founders, we have two follow on bets we do. One is unlikely winners, one is in definitive winners. And I just came up with a framework for my team because I have to train a team of people now right with this many investments.
I'll start with definitive winners, a definitive winner. In our definition, there's a there's a Lee a notable lead investor doing this round Sequoia benchmark, you know, go right down line. So there's a notable lead pricing the round. And the revenue has grown three x year over year.
So just if you just take those two things, how often do you see that in your portfolio, you know, Jason Schuman, how often do you see, we got benchmark leading the next round,
and it's tripling revenue over here. It's not often right. It's a it's a it's a unique event when those two things are occurring. So that's definitive, we all know. And maybe that's 5% of the time, if you're lucky for a seed fund that those kind of scenarios happen. And then we have likely winners, and likely winners, we're seeing two or three x year over year revenue. And we're
seeing a lead, maybe it's not the top tier lead that we would want. And then we say, try to say
no to everything else. And we've now communicated to our founders, we are a seed fund. Our agreement
with our LPS is we do not do bridge rounds, we do price rounds. And so and that's the truth. That's what I pitched LPS because now these series LPS who we have are saying to us, what is your follow on strategy. So I had to clearly define it and I just clearly defined it. We're not doing bridge rounds. We're not doing you know, these internal rounds unless it's like, five x revenue, right? Like if there's something crazy going on. But that's like, if you're if you're growing revenue,
five times year over year, shouldn't benchmark or Sequoia or somebody be coming in? Yeah. So
you know, that's the kind of, I think, discipline you have to have. And I think it comes from
SPEAKER_03: having a couple of funds under your belt, and having to face the scrutiny of LPS who say,
tell me about this investment. Tell me about that investment. Oh, you followed on with this one. It was struggling. Why did you do that? Oh, because I like the founder. Oh, the founder got to me first. The founder told me a good story. I'm founder friendly. You know what? You have a
portfolio strategy. And I've told my internal team, it's a competition for those dollars. And the competition is amongst the top six or 7% of the portfolio. So there's 300 names in the portfolio, and the top 20 get to compete for those dollars. So you know, more than nine out of 10
do not qualify for the top 7% by definition. So it gets a little bit easier as you get older, and you just have to communicate it to the two customers, LPS and founders. They just I think
if you tell it to them straight early on, everybody's in alignment. I don't know what
Jason human I don't know how many years you've been doing this now. So tell us how many years and what's your philosophy? Yeah,
SPEAKER_00: not nine years at this point. I mean, I'll tell you a couple things. So one, you know, I've had this exact same conversation with the Josh Koppelman first round and Jesse over at ia. And our three funds all look back at the historical data and all of our funds. And basically, what we found was that if you like survey all your partners in the middle of a fund, and you take the top third, the second third and the bottom third, the top third is definitely where you want to concentrate your capital, by the way, like everybody knows that because if you look at funds, and I've looked at the fund and portfolio breakdown of funds that have returned over 10 x before with one of our LPS, and 91% of the value came from 14% of the investments, however, 23.9% of their capital went into those 14% of investments. So concentrating capital is a great strategy. However, what we also saw all three of our funds, there's always one or two fund returners that comes from that bottom third or that messy middle that you never would have anticipated. And you look at a company, you know, like alloy, and they're in our portfolio, and Lightspeed did a big round, that company basically had zero revenue, we wrote three checks, well, it had zero revenue, you know, and all of a sudden, it was up into the right. And so I think what you really need to do is you need to either a of the trust of your LPS, but B, you need to have a lot of conviction if you're going to be writing checks in those bottom two thirds. Otherwise, you should be putting all your money into your letters. How do you find that conviction? What are the non, you know, tripling revenue, non metric ways
SPEAKER_03:
that that you did it, Jason? Yeah, candidly, I your job is very different, I think than my job at the end of the day, where
SPEAKER_00: like, we I'm literally talking to our founders almost every day, because I only work with, you know, three or four new ones a year. And so and we have different people at our firm who work inside those companies, you know, one day a week. And so we're using asymmetric information, make those calls. And so if you're a founder, and you're moving super fast, and you're learning really quickly, and you're iterating, finding product market fit, where it feels like there's signs of that, great, we'll give you capital because we think you'll
finally hit it. But if you're not learning super fast, and you know, we give you some, you know, advice, and you're not taking it or you're not going out and getting great advice, then unfortunately, you know, there's probably other things that you should be doing.
SPEAKER_02: I love that answer.
In those cases where you have this asymmetric information, because you're spending a lot of time with the with the team, are you doing a conviction based bridge round? Are you bringing in outside, you know, funding to go along with your dollars?
SPEAKER_00: Give you a great example. So our LPAC gave us approval to lead later stage rounds now in our portfolio companies, when we had conviction, the outside world didn't. So this actually happened recently, three separate times. In every time that this has happened, we gave a company a term sheet
for an eight to $12 million check from us, which as a seed fund is, you know, really big, but our opportunity funds 150 million. And that round became oversubscribed by 30 40 50%
afterwards. And it was just because, you know, I think we're in this weird time right now in the world, where sometimes, especially with the later stage companies, they just like are having trouble figuring out where's pricing and people don't want to get fired because the market's still figuring itself out. But at seed, you know, the answer at the end of the day is we usually are the ones who are stepping up pricing it increasing exposure, because why, you know, if you're going to write a check, write a check, and then go out and try to bring in some other folks as well. And you mentioned the three, the third, upper third, middle third and bottom third. Is that
SPEAKER_04: from a revenue standpoint? Or is that qualitatively have you had companies in the quote unquote, bottom third, the ones that you have least conviction and really be a fund returner?
We have had yes, we've had fund returners come out of the bottom.
SPEAKER_00: What are the lessons learned from that? What did you guys miss?
SPEAKER_00: What did we miss? The market usually catches up. So one thing I fundamentally believe in
is that you can put a great founder in bad market, the market will keep its reputation, the founder won't. And oftentimes, you know, we have been right on the idea, but wrong about the timing. And sometimes the timing catches up. And then all of a sudden, that's when you, you know, start to see things take off, the world catches up to the founders vision.
SPEAKER_03:
In some way, and I think that's like super profound. Yeah, speaking about the world catching up M&A activity is finally starting to pick up.
SPEAKER_04:
It's reported that PE firms Bain Capital and Hellman and Friedman are in competition to acquire DocuSign may even end up partnering together on the deal. After the news broke,
DocuSign shares were up 5.3%. According to a BA of A analyst, the company could potentially see a buyout of up to $95 a share based on comparables. Is it now time for the M&A market to start to heat up? What has been present when M&A has heated up historically? Generally, you know,
SPEAKER_02: capital scarcity and money sitting on the sidelines. That's definitely true. There's a lot of money sitting, especially we're seeing in some funds that we're in,
where they're now getting inbound from PE firms, sort of growth equity, you know, tech growth equity firms, and they have a lot of dry powder, and people can't sit on the sidelines forever. The IPO is what I'm watching. I think we saw today there's rumors Reddit is quietly filing
SPEAKER_03: and to go out in March stripe, obviously, ByteDance, Plaid, there's just a ton of backlog inventory. And these private equity firms, I don't call them bottom feeding, but they're looking for
a really good deal. I mean, they're the most value conscious. And so if they want to buy Zendesk or DocuSign or whatever they want to buy it, reorganize it on a Google spreadsheet in Excel and make it super profitable, and then flip it for max return, right. So if they're active, and they're seeing opportunities, that means maybe there is some market opportunity. And this does dovetail with it with the layoffs and being more fit, as Brad Gerstner says, you know, as companies get more fit, and founders accept, you know, you know, financial discipline and throwing off profits, the companies become more attractive. Companies that are losing money
SPEAKER_00:
SPEAKER_03: are not attractive in M&A in very accepting very rare instances where, you know, they have some strategic value, when they become money printing machines, like Uber, like Airbnb, you know,
having talked to the Airbnb founders, like, when they started becoming profitable, and the cash flow started, man, did they get treated completely differently by Wall Street. And so I think that's,
that's going to change everything as founders work through these like really difficult times, and the companies become profitable, and the balance sheets look really good,
which takes founders a couple years coming out of ZURP to clean it up. That's when I think
everybody gets a little greedy.
Jason is the the bid and ask spread is that is that coming down a bit? Great question.
SPEAKER_02: That's been the problem like last, you know, faulted, you know, I don't know if that's changing or not. Yeah, I mean, Instacart took the medicine, right. So they get the bullet,
SPEAKER_03: they went out at seven or 8 billion or something. And now people are saying, wow,
SPEAKER_03: it's such an attractive valuation that Uber could buy it with no problem. They could buy it for like
40 to 30 or $40 a share, I read like they could buy it for a much higher price than it's currently trading at. And it would make sense in terms of the arbitrage between Uber's valuation, there's an out Uber might be able to do it. When people start having those moments of greed,
right? Like a healthy greed. That's when I think that shows the market has turned a corner. And I
think feels like 2024 could be the year that that happens. I'm super excited to see exits happen so
that LPS can feel like this business is viable again. I think some LPS are like, is venture
viable? Is and I'm like, are we really having that discussion? venture is venture capital viable?
SPEAKER_03: Not at the ZURP lunacy. It doesn't it wasn't viable. But what we do every day, you know,
sticking to our knitting? Yeah, of course, it's incredible.
SPEAKER_04: On the 10x side, we do quite a bit in the public markets. And one of the consensus views is that if Instacart had actually gone really well last year, there would be a flurry of IPOs. There's certainly a lot of pent up demand behind Instacart. It's one of the largest IPO pipelines, I think, over the last several decades. So I think a lot of the success will actually depend on a Reddit IPO. And whether IPO investors are able to make money, the only people that made money on the Instacart IPOs were the ones that bought it on the IPO day and sold it at the end of the day. And that's not healthy for for the IPO market. So I think people made fun of Uber and Airbnb for years over the
SPEAKER_03: same exact issue. And then all of a sudden, you know, it turns a corner. So I just keep thinking
SPEAKER_00: about incentives at the end of the day. And you know, if you're a founder, get profitable, open up the market to a PE acquisition, because if you're not profitable, it just turns out a massive chunk of the market for you. And on the public market side of things, look, I think going back to your your comment about VC, there's gonna have to be some companies that go public that
are going to be below their last round price, because we all need liquidity in order to keep this engine rolling. Well, this has been an exciting episode. We covered quite a lot on
SPEAKER_04: liquidity from Jason Schuman at Primary Partners, Raja Todala at Churchill Asset Management, of course, JCal, the world's greatest moderator. This is David Weisberg from TenX Capital signing off.
