This Week in Startups - Dave Mcclure & Jordan Stein on YC, "Spray and Pray", and Games VCs Play | E1923

Starting point is 00:00:00 The last investment we made out of our fund one, which was last fall, I want to say, was 776. Alexis O'Hanian's fund, a lot of respect for, you know, what he's built there. And obviously, that goes back to the first thing we talked about as he was with Gary at that initialized. And he was the co-founder of Reddit for the record. That's also, yeah, you're right. I know. I was getting there, too. Lest anybody forget in their tweet at a firm that he co-founded.

Starting point is 00:00:27 You know why it's so contentious, right? Because they're so little at stake. It's just a tween folks. People are starting to spill tea and shade over a tweet. I mean, how do they leave him out? I was a co-founder. This week in startups is brought to you by Mantle, the AI-powered equity management platform designed for modern founders and operators.

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Starting point is 00:01:27 Are you one of those companies that knows you need to be using AI, but you're not even sure where to start? Well, then you need KiroTech. They are AI experts, and they're offering Twist listeners an AI strategy roadmap tailored to your business for $5,000. That's 50% off the normal cost just for telling them we sent you. Check out KiroTech.com slash twist and get $5,000 off. Welcome back to this week's liquidity podcast. With me today, I have Dave McClure from Practical VC. Next, we have Jordan Stein from Crescent Partners.

Starting point is 00:02:03 And of course, Jason Calacanus from the launch fund. I'm your moderator, David Weisberg, co-founder of 10x Capital. Today, we have three topics on the docket. Another YC company is going public. VCs are calling more LP Capital. We'll end with the latest three investments from our guests. Let's dive right in. But its IPO represented yet another YC company that has gone public,

Starting point is 00:02:27 joining YC alumni Airbnb, Coinbase, Dropbox, Instacart, and 15 other YC companies that have gone public to date. Despite the significant success of YC and the hiring of new CEO Gary Tan, some are concerned around current batch sizes and the future of YC. Dave, you founded 500 startups in 2010, and for a long time, you were one of YC's top competitors. What do you think of where YC sits today? I'm flattered. Do you think I was a competitor?

Starting point is 00:02:57 YC was always the big gorilla and probably still is. I guess I'd say we were also investing in a lot of YC companies, even though we were competing with them. So I think for the first five years of our existence, 2010 to 2015, we probably indexed into 10% of the YC companies. And we actually had several big wins. We were in GitLab, Plan Grid, a little bit in Stripe, and also I read it.

Starting point is 00:03:20 YC is still top of the heap. They're really well established. They've had several very large outcomes and probably the biggest community on the planet, I think. You and YC today were both criticized at some point of a spray and prey strategy, which is somewhat of a derogatory term. Tell me about at 500,

Starting point is 00:03:44 how did your spray and prey work and given your portfolio size, how are you able to execute on that strategy. I won't take credit for starting that. I think it was probably SV. Angel that really started that on Conway and to some extent, maybe first round capital and a few others. But at one point, we were probably doing the largest number of investments per year,

Starting point is 00:04:06 whether that's something to brag about or not. I mean, hey, the name was 500 startups. It wasn't 50 startups. It wasn't five startups. Well, I mean, at the time, Dave, in fairness, people thought it was crazy that a firm would ever hit 500. here we are, I think YC is at like 4,500 or 5,000 over 20 years. So you start, you know, doing the math on that.

Starting point is 00:04:29 You know, it's 250 a year on average, and they're doing 450 a year. So they're doing 500 startups essentially every year. So you actually nailed it, you know, and I think Spray and Gray is a derogatory way to sort of look at the strategy of, can you help, let's say five times as many startups, then a seed fund would do. And what I see is like a perfect ecosystem now. 20 years ago when we were all trying to figure this out, there were no angel investors. In fact, I started this Open Angel forum. Dave was doing 500 startups.

Starting point is 00:05:04 Naval was doing venture hacks. And of course, Paul Graham had started before all of us, maybe six or seven or eight years before us doing by Combinator. And yeah, and when you look at that, At that time, there was like a $3 million seed round or a $2 million series A. There really wasn't much going on in the Angel space. And now, fast forward, you have Angel List, which venture hacks merged into, and you have a ton of accelerators and even pre-accelerators.

Starting point is 00:05:34 And so Spray and Pre-Pray is a derogatory way to say, I'm going to make five times as many investments for the same valuation as seed funds are. So seed funds are investing at $8 million to $10 million valuations. Generally speaking, I think we'd all agree. If you look at 500 startups launch my accelerator or Y Combinator tech stars, you get 125K for 7% is the standard deal, which means you get to do four, five investments for what a seed fund does. What that means is you can take a massive amount of risk. So the hit rate is very low for accelerators.

Starting point is 00:06:13 even a great one like Y Combinator. But you get to get more swings at bat than a seed fund. So I look at it now. It's almost like a perfect ecosystem has emerged. If you really want to do a lot of work, you can run an accelerator. It takes 10 times as many people, in my estimation, to run an accelerator than a seed fund. A seed fund can simply draft off of what comes out of accelerators and place bets at $10 million, whereas we're all placing bets at $1.7. and five. We're just rounding up to two million. We're placing bets at $2 million

Starting point is 00:06:47 valuations and then we have to do a ton of work for 15, 16 weeks with the founders. So it's kind of a perfect ecosystem. I see it as like a perfect conveyor about now. It was a little sloppy and messy and confusing 20 years ago, right? Dave. Well, I'd say it's maybe perfect in Silicon Valley. I don't know about the rest of the U.S. and certainly not the rest of the world. It's not quite as competitive. But I would agree with you. We were generally getting in. We were, we were sort of a hybrid because we did both an accelerator and we did a seed fund. And so our seed fund valuations were probably in the four to five million dollar range at the time, at least in the

Starting point is 00:07:23 US, maybe a little less outside. The accelerator valuations were between one to two million. I think that's still the case today. So all in blended, we were certainly below five, probably around three or so. We were doing about two to 400 companies per year for those first six, seven years. I started 500, ran the first four funds, and I think we did about 1,800 companies in 7,8 years for those first four funds. I think 500's up to maybe 3,000 companies or more now. But the hit rates were generally, you know, as you're suggesting, you know, fairly low. About 65 to 70% of the portfolio would fail completely. we'd get a small win, say, 2 to 5x out of maybe 20 to 25% of portfolio.

Starting point is 00:08:11 We'd get large wins that were 10 to 20x maybe from 8 to 10%. And then we'd get unicorn, you know, IPO size outcomes, 50 to 100x or more from maybe 2 to 3%. I think most people would sort of say it's in the single digit percent range, low single digits. The thing that we didn't necessarily know in the beginning, but we'd seen a few of is we would occasionally get these really, really big outliers, talk desks, Canva, you know, to some extent a few others, Solana, that were thousand X outliers.

Starting point is 00:08:42 So those would only happen, maybe three to 500 companies, one out of every three to 500. But they do happen. I think if you look at the YC portfolio, they probably had at least five or six of those really, really large outliers. Coinbase, Airbnb would be the two that have,

Starting point is 00:08:57 you know, these decoorns are hard, right? Yeah. We talk about unicorns, but. Stripe, yeah. And then Dropbox has been always around 10. Instacart's been sub 10. So just even getting, I think we need to really have a conversation about decoorns versus unicorns, right?

Starting point is 00:09:14 Because there's a, you could hit one decoicorn. Robin Hood's 19 billion today. And you think about 19 billion, that's, you know, 19 single digit unicorns. Like there is a power law amongst unicorns, right? Yeah, but more than decoorn, I think the multiple makes a difference, right? because you might only have a 10x for series BVCs that get into unicorns that might not be that much. Right, exactly. But we were generally getting in at these $1 to $5 million valuations.

Starting point is 00:09:42 I think probably YC is getting most of their ownership at a sub, you know, one to $2 million valuation. Because I don't think they actually pay, they get a portion of that equity at a much lower price than maybe the rest of the LP buddy that they come in at. But it's, you know, it's a lot easier to get 100x multiple. You can't invest in that fund. You can't invest in the accelerator. Right. They internally own a piece of that, but not the LPs. But I'm just saying it's much easier to get, you know, a 50 to 100 X outcome.

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Starting point is 00:11:32 That's with mantle.com slash twist for your first 12 months free. See why hundreds of founders are switching to Mantle right now. Jordan, how many, how do you look at the accelerator space recede, just generally speaking, because it is a different beast than five GPs investing in, you know, 30 or 40 logos per very much. It's really hard to do successfully and to do. really well. Y Combinator, I mean, Dave, to your point, really stands at the top there and kind of better than the rest. And they have developed this incredible community over the last 20 years.

Starting point is 00:12:07 And I think just like any other ecosystem, right, it ends up sort of being worth the square of the number of users. And so I think that actually generates significant value that's hard for other people to catch. And so, you know, for us, we have a mix in terms of our portfolio being kind of established brand names as well as emerging managers. And I absolutely would include Y Combinator as like one of the best brand names in the world. A lot of people can recreate pieces of what they do in terms of providing capital in terms of mentorship, product market fit workshops, you know, all the time that they spend with their portfolio companies, but to recreate the power of that network and the signal value

Starting point is 00:12:43 too, right, in terms of if you were a YC backed company, that means something. And it still does. And a lot of GPs look at that for Signal. A lot of people attend Demo Day and do all of those different things. So from our perspective, I don't think we would compare other accelerators to YC. I think YC just stands alone. But if there is another group out there that perhaps is some other advantage, I mean, it could be a vertical advantage, right?

Starting point is 00:13:09 There's some interesting kind of AI accelerators or consumer accelerators or people who, you know, in their own way, open the same types of doors that YC does. That could also be really, really interesting. But I don't know that anyone's ever going to catch YC just given the massive lead that they've establish themselves. Jordan, how do you play an ecosystem like YC? Do you do an index style approach or do you look for funds that are stock pickers? It's a good question. And I don't know that there is necessarily a right answer to that. I think both strategies can work. And I also think it depends on your broader portfolio construction, right? So the way that we put a fund together is when we are evaluating a

Starting point is 00:13:49 manager, not only do we want to understand, hey, is this strategy going to work? And I think, frankly, if you were to create an index on everything that YC's done, you would be very, very happy with the results. You'd be happy with 20% of those results versus if you were actually able to repeatedly find alpha within that YC portfolio, that could also produce really high quality results. I think part of our decision making also depends, well, what else will be putting in this portfolio? How much overlap is there going to be between strategy X and strategy Y and strategy Z? Because there does become a significant amount of club deals and things like that that happen. So something we need to look out for.

Starting point is 00:14:24 That said, we've looked at really compelling strategies where people have put 70% of their fund investments into YC companies. And I think one of the differentiators I've noticed is some of those people actually bring YC companies, right? And so that to me identifies a little bit more from that LP, from that GP, from an individual, their ability to kind of do this more consistently. It's not just, hey, we're absorbing the value and sort of a derivative approach to YC. we're actually also as good at finding those types of opportunities ourselves.

Starting point is 00:14:58 And so, you know, that's probably a little bit more interesting to us. If I want to just sort of create an index around Y Combinator, it'd be better to find a way to sort of invest in Y Combinator, which, so you can't access the early stage, the batch fund in a vacuum, you know, there are ways to sort of play into that ecosystem. One thing about YC is it's great, but you also have to be aware of what the entry point of evaluation is. I think these days, if you're investing at YC Demo Day, prices, you're probably investing at $16 to $20 million seed round valuations. And possibly the best of

Starting point is 00:15:31 the companies have already been funded. So actually, you're indexing, negatively. They will deny, but we all know is not true. And they'll be sharp elbowed if you bring it up. And I think it's funny to, you know, you look at a group's portfolio and they'll say, oh, we're, they'll have front and center on their website. We're investors in Stripe as an example. And it's like, okay, well, you know, When did you get in? We got in at their $100 billion round. It's like, well, then I don't care that you're an investor in strike, right? And so I think to your point, like, yeah, entry point absolutely matters.

Starting point is 00:16:02 We've looked at plenty of funds who are like, oh, we invest in these YC companies and look how well, YC's track record is. And like, is that your track record or like what's going on there? So it matters. I mean, I think if you are doing the entire index of YC companies, you're going to get a great return because there are occasionally the coin bases, the stripes that are in that group Airbnb. But if you're stock picking, particularly at Demo Day, you're paying a pretty high premium to select and pick, and you may not be picking the best of the companies, either because

Starting point is 00:16:35 they're not necessarily a great stock picker. That was easier 10, 15 years ago. We were doing 10% of their batches. The batch size then was only 20 companies. It wasn't really that hard to pick two or three companies if you thought they were great. And the intrepoint evaluation at those times was probably only between 5 to 10 million. So it was a slight premium to market, but it wasn't a three, four, five X premium, which is, I think, kind of what you're playing for today. We've looked at a lot of track records. I'm pretty confident that if you just take their track record in their batches, that it is the best early stage track record probably of all time. It's really, really incredible. And Jason, you nailed it, which is when you're getting in a

Starting point is 00:17:18 $2 million valuation for all these companies and you're hitting unicorns and decagorns and and then some, it's just, it's non-enoperable. Yeah. But I think there are still companies that they're going to miss. And, you know, when we were getting started, we had to pick, you know, a strategy to compete against them. And it was difficult. We had already started five years later than them and tech stars.

Starting point is 00:17:38 And so we went, you know, one thing was scale. We immediately were trying to do large scale, you know, hundreds of companies per year. We were trying to do outside the U.S., which was at the time, you know, YCE wasn't doing a lot of stuff outside the U.S. And we were betting on underdogs that we thought were overlooked. And at the time, I think they were indexing a lot into MIT and Stanford grads, a lot of CS majors, and maybe to put too fine a point on it, a lot of white guys. And so we were trying to invest in more women, in more minorities, in more international

Starting point is 00:18:13 founders. And I think that worked for a while. When Sam came in and took over from PG, I think he also kind of recognized. the value of large portfolios. He started scaling a batch size. They started doing more international stuff and they also, to their credit, started investing in more women and minorities. We had a differentiated advantage for the first four or five years, but I think Sam was pretty sharp and sort of looking at where those advantages were and trying to compete them away. There are two things I've heard from, you know, people who are Series A investors or seed funds.

Starting point is 00:18:46 one is when you go to YC, a lot of the top companies have been basically don't wind up at Demo Day. They skip Demo Day. So that would be like playing in a poker game. And I said, hey, you know, Dave, you can get Aces and Kings and Queens, but the rest of us, we can only get Jacks, 10s, 9. So let's see if we can beat Dave, you know, but he gets all the Aces Kings and Queens. And, you know, that's fine. No conflict, no interest. there's a cobble of folks who are on the inside who Paul Graham's liked for a long time or

Starting point is 00:19:19 Andreessen Horowitz or whatever, and they sort of share the best of deals quietly and they don't go on stage. They'll deny that, but everybody knows it's true. We know examples of it. The second thing I've heard from folks is demo day is not, that's kind of the suckers bet on Demo Day because it's overpriced, you know, towards what Dave is saying compared to. It's retail. Traction. It's retail. So the price is going to be 20,000, you know, let's say 20 million for a company with no traction that's got six weeks of like private data

Starting point is 00:19:49 but a great story. And I think that's one of the problems is people go to IC to maximize their valuation. Okay, that's fine. But it can go too far. And if you have too much demand from dentists, like one time I went there and it was like literally the person sitting next to me at Demo Day was a son of a dentist.

Starting point is 00:20:05 And I said, oh, what do you do? He said, oh, I just want to be an angel investor. I read your book. We take a photo. I said, yeah, sure. And, you know, he was just in that high pressure cooker. And then they came up with this high pressure tactics. Oh, you know, the valuation's 14 million this week. It's 18 million next week. Then it's 24 million. If you sign now and you wire.

Starting point is 00:20:24 And they, you know, kind of came up with almost over-optimizing to kind of create FOMO. And I think that's where a lot of the bad feelings about why Combinator Demo Day kind of rooted themselves. Hey, it's a rigged game. Hey, there's high pressure tactics. I think that's come down a bit. And I know Gary, you know, even Sam Walton before him, they were not encouraging people to kind of do those things. But that is the truth. So what people have told me is, oh, it's just best to meet the companies, but then wait one year. They, you know, they'll deploy a million or two million.

Starting point is 00:20:56 And the valuation then has to catch up. So let's say you did get that $20 million valuation. You did raise the $2 million, as David is nodding. We all know, you deploy that $2 million. Okay, you went from, let's say, $0 in revenue and a beta. now you've got, let's say, 500,000 in revenue, making 50K a month, 40K a month in reoccurring revenue, $500,000 for the year, okay, what's 10 times that? What's 30 times that?

Starting point is 00:21:20 Okay, 30 times that is 15. So now you're, if you're based it on 30 times that number, or 40 times that number, it's the same as the Demo Day evaluation, and that second extension will be the same price as the Demo Day. So that's, and I have actually seen that. A lot of folks coming out of Demo Day, they secure the bag. like 15, 20 million, they get minimal amounts of dilution, fantastic, great job founders. But then when they come back to market, it's basically the same valuation.

Starting point is 00:21:47 So we will wait on a lot of valuations. And the truth is they only accept 1%. We accept just under 1% to our program. They get 45,000 applications less they tweeted and we get 20,000 right now. So we're kind of right behind them. And what I would tell you is neither of us know in the 1% or 2% of the top companies, which ones will break out. And I think Dave would confirm that,

Starting point is 00:22:11 having done this longer than I have, that is there any, do you feel there's any difference between what you determine is the top 1% of applicants or the top three? Could you know? That's what I was going to say

Starting point is 00:22:21 is I think, you know, a lot of times, you know, the hot companies supposedly are the ones that already get funded, but those aren't always the hot companies five years later. And a lot of times,

Starting point is 00:22:31 you know, people may change what those are. But I, I say, Airbnb were unfundable. Coinbase too. Coinbase was not a hot company in their cohort.

Starting point is 00:22:42 I had a chance to address in Airbnb when they were doing the cereal boxes and I thought that was kind of crazy, but turns out I was stupid. But I think, you know, I would still say the top 10% of YC companies are probably worth it, but you just don't know

Starting point is 00:22:57 which 10% those are. But still to their credit, I mean, YC's built an incredible enterprise. It's very tough to compete with them. And I think you have to pick your spots If you're going to do something, you know, I think the new program,

Starting point is 00:23:11 Neo got a little bit of, there was some punching that was going on between Neo and YC, I think maybe six months ago. Yeah, they were definitely threatened by him big time. Did you see how nasty they got? They were like,

Starting point is 00:23:21 we're going to take this guy down. He got in a lawsuit with the founder. It got really sharp elbowed unnecessarily. They're all, that's the other thing is they're a bit sensitive, I think, like any time any critique happens, they,

Starting point is 00:23:31 everybody, like they make it into a whole, like, we're the underdogs. And it's like, you're not the underdogs. Why see? It's kind of the opposite.

Starting point is 00:23:38 You're the 800-pound gorilla. You're not the underdogs, but smart branding on their part to attack him. But I think if you're going to do an accelerator these days, it's probably difficult to be a broad-based, you know, global accelerator unless you pick a category or geography or something speciality. Like I think probably Antler, maybe entrepreneurs first, a few others, you know, 500 and maybe Seed Camp are trying to compete globally. and they do have some advantages.

Starting point is 00:24:07 I think I take the other side of it. I think it's easy to compete with them. The majority of publicly traded companies. If you pick a vertical or a geography or some specialty, I think you can compete. But I think it's harder to compete just broad-based. Now, see, I disagree. I think if only 1% are getting accepted, I think the second, third, fourth, and fifth percentile is the exact same.

Starting point is 00:24:25 I don't think anybody knows the difference between those five, the top 5%. Like maybe you could say, hey, this is the top 10% versus the top 20. But I think in the low single digits, they don't know, we don't know. Antler doesn't know, 500 doesn't know which one of those is top 1%, 2% or 3%. And that's why we do large portfolios is because you don't generally know. Exactly. And so I think it's that people don't want to do the work. It's really hard to do an accelerator.

Starting point is 00:24:51 You have to meet with thousands of companies to pick 100 companies. And then you have to deal with, let's say there's two and a half founders per. You got 250 founders who then want your support. and what your continued investment. It is exhausting. Most VCs and GPs are lazy. They want to do one meeting, two meetings a day, max. When you run one of these accelerators,

Starting point is 00:25:16 how many meetings were you doing at the peak a day? Because I know my team is doing 70 introductory calls per week. We're at 70 per week. Think about that. I mean, we had similar numbers. I don't know where 500 is at these days, but thousands of applicants, hundreds of screenings.

Starting point is 00:25:33 And we sort of just, on batch sizes that were around 30 to 50 companies, you know, but we were running them four times a year and two locations. I think YC is now doing north of 200. They came down a little bit, right? Yeah, I thought it was 25 or 250 per cohort. I think they hit three in one, maybe 300 was the peak, which would be 600 a year. That's too much. They're also, what, sharding those into, you know, categories in vertical.

Starting point is 00:26:00 So even though there's two or 300 companies, I think there's probably, you know, X number of companies in. in some sector vertical, genetics, AI, life sciences, whatever. All right, everybody, you know I am a podcast addict. I love finding new pods to help me grow as a CEO and as an investor. And recently, I've been listening to a podcast that is a goalmind of marketing wisdom. It's called Marketing Against the Grain. Brought to you by the HubSpot YouTube Network. And this isn't just another marketing show.

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Starting point is 00:27:02 So here's your call to action. Get ready for a treasure trope of marketing insights that will keep you ahead of the curve. Just do a search. Marketing against the grain on YouTube on your podcast player. You'll find it immediately. Subscribe. And remember, it's brought to you by the HubSpot YouTube network where they got a lot of great shows. Dave and Jason, I'm curious from your perspective. Let's say there's 40,000 people who apply to Y Combinator, obviously very, very small amount actually end up getting in. How much. of the remaining group, how many of them do you think are going to choose to go to another accelerator or just say, you know what, it was YC or bust for me? No, no. The majority of them will go to another accelerator. We know because we are now moving our dates to the week after YC sends out their confirmation. We don't really need to compete with them if 99 plus percent don't get accepted.

Starting point is 00:27:56 So many of them will go to another program. and we've had many successful ones come through our program and become unicorns or, you know, sent a million valuation companies already. So there's plenty of opportunity for those folks to go to other programs than they would. I think there could, I think there should be more competition for YC. And I think who is the guy who they attacked again? He made the, he doubled. I think he doubled their deal. I think he offered $250 for 7%.

Starting point is 00:28:27 And once they did that, once he did that, that really upset them. And they really went after him hard. So if you could get twice the economics from him, he knows a lot of people who's got a smaller size. I would actually advise going to his program. And I think a lot of founders did. I think that's why they were threatened by it because he just doubled their economics. If you double YC's economics, you would peel away a third of the company, something, with a reasonable product. I think YC has a really strong value ad for their program.

Starting point is 00:28:57 And so it's not always just based on the economics and the numbers. I think they've built a brand that sort of, you know, feels like Harvard or your brand, whatever you want to pick. And so you, you know, you can compete with them, but you have to be, you know, the Stanford alternative in your field or you have to find, you know, your piece of the ecosystem that is attractive. I think, Jason, one of your points, I would say people have been competing around dollar sizes.

Starting point is 00:29:25 They haven't really been competing around equity portion. I think there's probably room for someone to compete by cutting the equity down to like two to three percent. Even if they offered a smaller check, even if they offered a smaller check, you know, I think you could probably have an interesting program if you offered the same amount of money for three percent. Yeah, you go the other way. We actually realized that in the market. I was talking to pioneer. So this is a really interesting concept. and I had the founder on this week in startups at one point,

Starting point is 00:29:59 Pioneer. app, and they weren't originally offering money. And I said, you know, you have all these people doing this like virtual accelerator. Why don't you just give them 10K for, you know, 1% or something, right?

Starting point is 00:30:15 And see how that goes. And they were like, oh, that's interesting. And so then I started doing it. So we offer people at Founder University, their first check, if they haven't raised money before, 25K for 2.5%, 1 million dollar valuation.

Starting point is 00:30:29 And we did it as an experiment, and we put it on their weekly check-in form, Dave. And when we did, 60% of people asked for the 25K checkup. 60%. So I read it like an experiment. I was like lean startup. Hey, would you like this?

Starting point is 00:30:42 We've done, I think, 80 of those checks so far. So there is definitely like the first check-in, 25K. We're not incorporated yet. We're just two or three co-founders, you know, with a business plan or a mock-up. people will take that 25K check. I've confirmed it in the market. I'm glad I'm not in that business anymore.

Starting point is 00:31:00 It's very good. It's a lot of work. It's exhausting. I can tell you because I'm exhausted sometimes. It is exhausting. I would agree if you find good people, if you have a value proposition that's differentiated, particularly these days,

Starting point is 00:31:13 I would say, competing on a vertical focus or geographic focus makes a difference. You need to have a real place to add value, whether that's on product, on growth, on people. But if you can really deliver on that, then I think you can be still competitive. And people who are complaining about why Combinator

Starting point is 00:31:33 or the terms they get or the price of companies coming out, just create a competitor. That's what I did. And, you know, we get into deals at the same terms as them or earlier, and we have our own proprietary deal flow. So do the hard work like Dave did, like I did. There's no need to complain about them. You can just compete against them.

Starting point is 00:31:53 And you will succeed because 99% don't get in. There's a lot of successful people in the country who didn't go to Harvard, by the way. I know it sounds crazy. And again, I think just people need to recognize that, you know, PG did an amazing job with Jessica getting it started. Sam took over, did a great job. Michael Siebel did a great job. I think Jeff, sorry, forgetting also ran it for a little while. And Gary is, you know, new, but he's not really new.

Starting point is 00:32:23 also a YC founder, and he was running initialized for a bunch of years. So they've had a great string of quarterbacks, if you will, running that program over there for, you know, 20 years. Moving on, Carter is reporting that capital call requests hit a high in January, not seen since Q2 2022, signaling a return of VC bullishness. Capital calls are a leading indicator in that they represent a VC firm's expectations to invest capital in the near future. Jordan, as an active LP in the market,

Starting point is 00:32:56 are you seeing more capital call requests in this environment? We are seeing some. Look, our sample size isn't huge. You know, in our first fund, we invested in 16 managers. We just actually launched our next fund last week. And so still getting that geared up. But we are seeing a slight increase.

Starting point is 00:33:15 You know, it's nothing crazy dramatic. I think that there's probably a few, few reasons for it. Number one, I think there's a ton of money going into AI, as we all know. And so I think there's a little bit of a frenzy there and a little bit of a hype there. And that I don't think that's going to slow down

Starting point is 00:33:31 in the near future. I think there's a little bit of, you know, okay, we're through a bit of the uncertainty in the market, right? Whether it's going to be a soft landing, a hard landing, you're seeing signaling of, you know, interest rates getting put. And so from my perspective, I think investor confidence is getting higher and that's driving some of this.

Starting point is 00:33:48 I think it's probably also, element of, you know, companies that fundraised in 2021 that have held off for as long as they can and are coming back and you're going to have to make some decisions around do you re-up in those companies and double down or do you not? And so I think it's real. I think all of that is contributing to what's happening. Have we seen like a 2x or a 3x in capital calls? No, but there is a probably statistically meaningful increase that we've observed, I'd say over the last, you know, quarter. Dave, your fund practical is a secondary fund

Starting point is 00:34:22 where you take advantage of different macroeconomic conditions, including the lack of liquidity and the lack of LP capital. How are you playing the macroeconomic conditions today? Well, I think it's pretty simple. The macro condition going on is that nobody's gotten any liquidity for the last two years. And so people need to find an alternative path to liquidity that's not, you know, from IPOs or acquisitions, although we're starting to see some IPOs again.

Starting point is 00:34:50 You know, I think the secondary market's always been an interesting place for people to look for liquidity. It's been around for, you know, 20, 30 years in private equity. It's even been around a pretty long time adventure. But what we are seeing more of now is funds looking for liquidity, not just individual company founders and investors looking for liquidity. So, you know, there's certainly a pretty active marketplace for individual company secondary, whether that's Forge or Equity Zen, which was a 500 startup's portfolio company and others. But there's not a lot of places to go find fund secondary positions or LP positions. And what we've kind of found is at least below a certain ticket size, other larger secondary players like industry ventures and

Starting point is 00:35:39 Stepstone, which acquired Greenspring, those folks are writing 30, 40, 50 million dollars checks. There's not as many people doing, you know, sub 10 million, certainly sub five million dollar tickets, at least at the fund level. So what we kind of found, and this was partially, you know, myself as a customer, I was looking for some partial liquidity in my carry in my first two funds at 500, about four or five years ago. There just weren't very many people who were buyers, at least at that time, and I would say still. If you're looking at non-institutional investors in funds, every so often those folks need liquidity. You're sending kids to college, you want to buy a house in Silicon Valley.

Starting point is 00:36:21 If you're talking about a family office, they might go through death, divorce or retirement, and there might be some restructuring in some of their venture assets. It's not really a solution that's as needed for institutional players who can be patient and long-term. But for the smaller LPs and sometimes for emerging managers who are still in their first 10 years, they're probably going to be looking for liquidity, particularly after going through the last two years. One thing I will say, we incorporate secondaries into our strategy in terms of our fund. And one of the things that we've noticed in terms of why we believe there is a little bit of a sort of lack of participation or if there has been historically is it's often really hard

Starting point is 00:37:03 to get information. And from my perspective, you know, if you're a part of that ecosystem and if, you know, part of that fabric, then you can get behind the door. If you're underwriting, you know, a portfolio or a single asset, if you don't have a relationship with the GP who is the investor in it and you're trying to, you know, buy a piece from someone else, uh, sometimes that GP will say, well, I don't, I don't, if you want to do the transaction, sure, but I'm not going to spend time to help you understand where this company is or isn't. And so, you know, we've kind of put that as a filter

Starting point is 00:37:34 from our perspective of like, okay, we're not going to, we're not going to engage unless we're already, you know, have a relationship with the manager. And so I think to be successful, you really have to have those relationships and a lot of those smaller dollars that you're referencing talking about, like there's no way for them unless they're otherwise involved in the VC ecosystem to really get behind that, that curtain and that wall and understand it. So I think that also impacts the decision making a lot more. more than it would in other asset classes. Yeah, I think even within secondary, there's a big difference between what's called direct

Starting point is 00:38:05 or company secondary and the strip sales, which are really portfolio secondary. There's a lot of people who, you know, both professional and, you know, I would say the tourist investors who are looking at individual company secondary and because these marketplaces have, you know, interesting names on them, people, there's lots of people who want to get into, let's say, you know, Stripe or SpaceX or Canva or something like that that's very well known. But again, like you said,

Starting point is 00:38:34 you're not really even going to know about portfolio secondary deals unless you're part of the ecosystem and have relationships there. You're going to need consent from the general partner of the fund you're buying into if you want to do that. So you have to be an acceptable investor to them.

Starting point is 00:38:48 You're evaluating a basket of assets, not a single asset. And so you have to underrate multiple companies. And then you also have to think about like what's the exit trajectory for those vehicles. So it's, it's a lot more complicated to do portfolio secondary than individual company secondary. But that said, for folks who are willing to go after it, because there's so few people doing it, you can get some really good pricing and arbitrage on that as a buyer. Okay, everybody, it's your boy, J-Cal here, and I've talked a lot

Starting point is 00:39:18 on this week in startups about how the smartest startups are shifting their engineering firepower to Latin America to boost their efficiency. It just makes sense. You just think about how many amazing developers there are in Latin America and they're on the same time zone. And of course, you're going to save money. The cost of living is completely different and the salary structures are different. So this is where Curatech comes in. C-U-R-O-T-E-C, Curate. When you partner with their team, they get you up and running quickly and they give you the ultimate flexibility to scale up or down as you need to. Curatech takes the headache out of things like payroll and compliance. And they just connect you with the best talent out there. They are trusted by industry leading innovators

Starting point is 00:39:58 like Automatic, the makers of WordPress, and Comcast. Find out why at curatec.com slash twist. Stop waiting and be proactive about hiring the right people. Head over to curatec.com slash twist, C-U-R-O-T-E-C.com slash TWI-I-S-T and get ready to boost your team's productivity with an elite Latin American engineering team at a fraction of the cost of a U.S. developer. And you'll get 20% off. Your first month. How generous. Thanks to the team at Curatech. Jason, you're in 24 funds yourself. Are you seeing more bullishness with these capital calls? No, it's pretty consistent, I'll have to say. It was a little bit slow last year. I think I saw some funds weren't drawing down. But I think it's pretty consistent. And it's not enough that I would notice it when I make a commitment. It's typically somewhere from 25K for these five to $10 million funds, 50K, you know, K, 1% of the funds.

Starting point is 00:40:52 fund all the way up to 500K maybe when I do these for my family office. And yeah, I kind of have that money set aside. So I don't even notice this, this, you know, minor spike. I do think what it shows more than anything is that VCs, the general partners at these firms, have dealt with a lot of the triage that was going on in their portfolio. So just anecdotally, speaking to other VCs on a regular basis, being on the board of some companies, you know, there were a lot of companies that needed to do a big riff, like two-thirds of the company. And instead of doing a two-thirds riff, like Elon did at Twitter, they did a 10% riff, a 20% riff, and then a 30% riff, and then a 10% performance riff.

Starting point is 00:41:37 And, you know, this occurred over 18 months of finally, you know, working with the founders to accept the reality that they didn't need 400 people for a $10 million AAR company. they needed more like 75 people or 100 people max right and so you know they there was a lot of that going on which i think was a distraction from putting money into new companies and i think jordan you said like there was just like some overhang right of i assume you were talking about valuations and like getting reset and coming back to reality so i feel like nine out of 10 of my four out of five or nine out of 10 of my, you know, challenged companies, the challenge has been resolved either by shutdown and aqua hire or a right sizing of the company. Do you think we're done with that?

Starting point is 00:42:28 Because I'm not sure we're done with it. I think that, you know, the active management of turning the corner has probably been done by many companies, but the ultimate shutdown decisions, I think that's, we're still going to see a lot of that. I was talking to a friend over at SVB and two or three years ago, there was an article last year that was written by Elad Gill about when these companies were going to round of money. And he was sort of, but he was talking about how a lot of those companies

Starting point is 00:42:56 had raised so much cash in 2020 and 21, even though burn was high. Those companies had three, four, maybe even five years of runway. Once the downturn hit, everybody started trying to reduce their burn and they extended even further. And so, you know,

Starting point is 00:43:12 I spoke to someone at SVB a few months, ago, they said, finally, the average company was down below 18 months of cash. And so my guess is, we're still going to see a lot of blood in the water this year and possibly into 25 where people have to make decisions now. Like, when you have three years of cash, even if you're trying to cut, like you said, you're not feeling like, oh, I have to figure this out tomorrow. This isn't, by the way, an issue isolated to venture. you have this wild, wild situation in public biotech companies where some public biotech companies,

Starting point is 00:43:48 their drug has failed and they're sitting on $100 million. And basically, public shareholders have to come in and do a hostile takeover and do some kind of negotiated agreement. It's wild times. Yeah, it's a common thing. But see, the thing there is that at least for public companies, those valuations get reset based on what people know about the companies. In private markets, they're not getting reset.

Starting point is 00:44:11 And so what's happening is VCs, we're all sinners, we're all liars. Almost every VC that I know is still holding their portfolios at valuation set in 2020 and 21. The first thing that we say when we talk to people about assessing value in their portfolios is, have you done any proactive markdowns after Q122? And if the answer is no, which is pretty much what it is for most of them, we're like, well, your portfolio is probably overvalued by at least 50%. you should be reducing or cutting by 30, 40%.

Starting point is 00:44:43 Jordan, how do you look at that? You have multiple funds in the same company. You see them carrying at different levels. How do you look at that? You have a really interesting conversation with one of the two managers, usually, and you say, hey, let's talk about this because this doesn't make sense to me. And one of your co-investors is holding it at a lower valuation and frankly, given what's going on in the environment.

Starting point is 00:45:06 And then they usually give you some line about how their policy makes in six months. And so they haven't proactively done it because they want to maintain policy, which makes them more conservative and consistent and all of that. Especially if they're fundraising. Yeah, exactly. That's an interesting point, too, is honestly, the ones who are fundraising are usually the ones who wait the longest to take the mark down. But truthfully, it's been a really important tool in our toolkit, especially in this

Starting point is 00:45:30 environment, to try and understand the real value of these underlying portfolios. And so, you know, one of the things we've tried to do is whenever we're speaking with a manager, you know, we're trying to understand that information and be able to reference it later so that if we're looking at, you know, Flung Manager X, we're going to say, wait a second, we've seen these few companies before. And in fact, they were marked at this. And so I think, like I said, sometimes it ends up being an interesting conversation. But honestly, the vast majority of the time, it's like, yeah, it's just our policy and we're being consistent. Don't you want us to be consistent? It's like, well, no, I need to be honest and realistic. But that's how it goes. I want you to do assess a fair market valuation. I guess this is the point that I kind of want to make, though, is the reason that these companies haven't been marked down is because there's no market pricing activities that are forcing them to do so. Unless these companies get sold, go IPO, do a down round, or shut down, those are not market pricing events.

Starting point is 00:46:26 And even if they're funding them, they're bridging them on notes that are not really setting a price, particularly for the folks who are bridging their own companies. They don't want to price them to where they really should be because then they'd have to remark their own portfolios. And if they're fundraising, that might mean bringing a three or four, five X portfolio down to maybe only a two or a two point five X portfolio. The other thing I would say is we're pretty actively trying to pay attention to where secondaries are at. And that can be an indicator too, right? If something is trading actively on a secondary market, doesn't force repricing, but it does allow you to ask the question and say, well, someone's paying this for

Starting point is 00:47:02 this asset. Yeah. And the fact that people are even paying anything for private market companies, I'll get some low ball offers for some of our companies. And I'm like, oh, well, that's great that there's a trade occurring, you know, at all. You know, the fact that some... There may not even be a price, yeah. Yeah, because in some cases, people are like, well, yeah, I'm not going to invest in that company. The overhang is too large. I have been getting a number of...

Starting point is 00:47:27 Some founders have taken it very seriously, getting to profitability or break-even. So I've started to get the infinity sign in months of runway. We are infinitely... Our number of months of runway is infinity. And I'm like, well, that's charming and awesome. Great. And then hope renews, which is what's happening. And people say, oh, well, if you're growing, you're at infinite and you've got $5 million in the bank, great.

Starting point is 00:47:52 And you're making $3 million a year. Great. What's the number going to be next year? And they're like, $4 million. We're like, oh, okay, can we have a conversation about growing faster and losing some money? So here we go again. What? Growth over profitability?

Starting point is 00:48:06 And then here we go. And I literally, this, I think like the second half of this year is going to be growth and reasonable investment, aka losses, reasonable burn in order to hit, you know, more aggressive growth topics because I think everybody was just like battened down the hatches. Let's make sure that our ship doesn't crash into the rocks. Okay, the storm's over. Okay, it feels like, okay, it could be choppy water, but it feels like the storm's over. okay, we're out of the storm. Okay, now, let's start a plan to grow this thing again. And I think that was hard for a lot of people.

Starting point is 00:48:43 And I'll just make a note to folks, and I've experienced it in my own career. Man, moderate success is as bad or more pernicious to break out success and is more of a blocker than no success. Because if you have no success, you just shut the company down. It didn't work. Failed experiment, we all move on. You get to three, four, five million dollars in revenue. You get this like tweener company. Okay, great.

Starting point is 00:49:08 We got to $3 million, but we can't move it up. The revenue is not coming. Okay, great. What do we do? And you're like, well, we have a $3 million business. Let's try this strategy to grow. Let's try this strategy to grow. And you just may have hit like the natural audience.

Starting point is 00:49:21 And you got to really, that's a tough one for founders. What do you do with the $3 million, $5 million, $10 million success, quote, unquote? But it's not a venture success. Have you seen any of those break out or they all stay meddling? I don't think it ever. Yeah, they just have to get sold. They have to get sold, spun out. Yeah, it almost never breaks out.

Starting point is 00:49:42 I have a favorite expression to describe the situation, which is usually winners keep winning, losers keep losing, and tweeners keep tweening. And very hard to move a tweener to a winner. I think in a few cases, you can pick your battles and try and get some folks, you know, back onto a growth path. But I would agree with Jason if they're, if they're, you know, again, this really depends. From an investor perspective, something might not be a win. that from an operator perspective could be a win, right? If you've got a company doing 10 million in revenue, generated one to two million in profits with modest growth,

Starting point is 00:50:14 that's probably not a win for an investor. That could be a great business for the operator. So it really does depend on your perspective there. And that's where the difficult conversation of buying out the investors has to occur. So they can at least take the loss or, you know, wind down a fund. You know, when funds get to 15 years, people just my understanding is buy the shares have their shares brought back for one dollar from the failed investments and or just try to sell them in a strip maybe to Dave or no do you find yourself that's not where we buy we're we're generally buyers around the seven year mark um you know so our optimization is for when you know we look for funds that are doing well where the losers have been written off and winners have emerged probably you know let's say it's somewhere between series B and D 30 to 50.

Starting point is 00:51:04 million and up in revenue. But there's a whole other business in secondary that's kind of like wrapping up end of life vehicles, establishing continuity vehicles. It probably happens between years 10 to 15. And generally, you know, we sort of bump up against that, but those other buyers are buying out the entire position of the fund or really what's happening is they're finding out the LPs who want liquidity. They're figuring out which are the core assets that are still growing. And then they basically can create a continuity vehicle with the high quality assets, roll in the LPs who are still patient, buy out the LPs who are not patient. And now you've got a great, you know, high quality portfolio you can run for another five years, whether that's maintained by the, you know,

Starting point is 00:51:48 the same managers or new managers. You're basically sitting on high quality assets that are hopefully heading towards an IPO, but you can extend the life of the vehicle three to five years and manage out, you know, the LPs who are patient and pay off the LPs who want liquidity. I think that's going to be a really big business that's going to start happening in the next couple of years. The other one that we are doing that I think is really probably on a lot of people's minds right now is buying secondary in strip sales to generate DPI. But there's a ton of managers who are sitting on paper gains and performance. Maybe I don't always believe that they've got 5x there. That's probably based on that 20, 21 valuation.

Starting point is 00:52:28 but they might have 2.5 to 3x of real value, but they have zero DPI or very small than DPI. And so, you know, IPO activity and honestly not that much M&A activity, I think you're going to see a lot of people doing deals to do strip sales to generate DPI. And those fund managers want to be able to raise their next fund. So that's another area where we're seeing a lot more interest from managers to do secondary sales. Are we seeing funds that are shutting down, looking for custodians to wind them down.

Starting point is 00:53:02 I know of like two funds I was involved in as an LP that are not continuing on. They're not doing a next fund. And I'm, you know, I didn't ask them explicitly like, are you going to manage this for the next? You know, it's your four of the fund. Who's going to manage it for the next 12 or 10 or whatever it is? Yeah. 10 years at least. Right.

Starting point is 00:53:20 Yeah. So what happens to all these fund managers who are quitting? It depends. It depends on whether, you know, the LPs are friendly or not, depends on whether it's an audited fund or not. Depends on whether they have winners in that fund or not. But I think that,

Starting point is 00:53:37 you know, half the audience is probably the default case, which is a lot of people jump into venture and don't continue. In fact, that's the majority case. And when these are larger funds, maybe there's some continuity there. They have management fees to live on.

Starting point is 00:53:51 But for most smaller funds, like you're not, you know, hosting for five years on the management fees. of a $5 to $20 million fund, at least in most cases. So I think those will probably bifurcate into the folks who have winners and or the folks who are committed to a career adventure. But for the majority of those folks who don't have winners or are not committed to a career, yeah, those funds are probably going to be

Starting point is 00:54:19 walking dead to some extent. It depends on what kind of support is required from the companies to maintain them. The real question is from the investor's perspective, you know, do they expect anything out of that? And are they expecting to get quarterly reports and who's watching the store? Have you had it happen, Jordan, to any of yours? Not yet. No, we have not. Haven't had it happen. Haven't had anyone's signal that it's going to happen. But, you know, our first fund, the first investment we made from it was 2022, right, into a net new 2022 fund. So we've invested into 2020, 2022, 23, some of 2024 funds. So I really hope nobody is thinking about shutting down within their first or second year.

Starting point is 00:55:01 That would be problematic. I've really enjoyed the first year. I'm out. It's between year four to eight when people decide to check out. I mean, you're past the investment period and you're probably past when you've had sort of the front-loaded management fees. When you're done writing checks and when management fees, you know, start to ramp down typically around year five, six, seven, if you don't have winners, a lot of people check out.

Starting point is 00:55:26 Yeah, it's a it's a paradoxical career because you don't know if you're good at it until year six or seven. Yeah, right. And so like how often is it like playing the, yeah, you can play basketball and we'll tell you when you get to year seven playing basketball or running marathons or being a chef. Like your seventh year as a chef will know if you're any good at it. It's like, hmm. Yeah. Well, if you have been able to raise a fund every like. like three to four years.

Starting point is 00:55:58 Right. You're going to check out if you haven't raised a fund in the last four or five years. That makes it. And that's a really interesting point, too, where it's like, okay, when we're, for example, going to re-underwrite a fund, right? And we're, let's say, for this current fund that we have right now, I'd anticipate, you know, half our managers are going to be re-ups from fund one. And, you know, what do we have to look at?

Starting point is 00:56:22 Well, the investment we made in fund one is not going to have a whole lot of performance. and to your points, it's not really like you can draw a whole lot of conclusions from it. You can look at, you know, did they say, did they do what they said they were going to do? Did they improve their team? Did someone leave? Is there any drama? You can look at their older portfolios and say, okay, they seem to think this thesis was going to work. And by now we actually see more of it working or less of it working.

Starting point is 00:56:47 But if it's a new fund and all you have to go on is, you know, one fund or even potentially two sometimes, that can be a little bit more difficult. What do you go off of that nexus? What are some leading indicators that you look at that help you make that decision? So it can be a number of different things. And I think it can be case-by-case basis as well. Our thesis around venture is centered around the following, which is, you know, is this individual, is this fund manager, this firm going to see the best opportunities and the best founders? Are they going to be able to win investments into those founders and into those companies?

Starting point is 00:57:20 And I think that's a really key element. and then, you know, how do we kind of prove that those two things are true and that they're able to pick the right ones from the bunch. And so in a lot of cases, you know, from our perspective, we're never going to invest in a fund one where that person hasn't invested in a company before. And it's like a true first-time venture capital investor. The three fund ones that we did in our first fund were all generally spinouts from institutional firms. And so, you know, there you at least know, okay, well, here are some of the companies they invested in. And so you can continue to follow that story. You know, we'll do new references.

Starting point is 00:57:57 We'll talk to their founders that they've invested in, you know, from prior funds as well as the fund we've invested in trying to get to the answer of, would you recommend this person to a founder friend of yours? Have they done the things they said they were going to do, right? And maintain the type of reputation where they will continue to be able to win deals and continue to be able to support entrepreneurs. It's a lot of qualitative work, I would say, and requires pretty significant resources to be able to get right.

Starting point is 00:58:21 And then we'll also talk to the rest of the community, right? We'll talk to other venture firms. So say, hey, you know, Andrews and Horwitz, you know, what's your perspective? You've been working with this group here on two boards with them, you know, how have they delivered over the last couple of years? How has that reputation maybe changed, not changed? And so, you know, talking to those GPs as equally as important. And then we'll talk to other LPs too, right, who are generally able to do similar things that

Starting point is 00:58:44 we can from those references, from their analysis, and really benefit from aggregating the information that they've generated along with ours within that community to try and make that assessment. But beyond that, it's not like you can run some model and say, yes, this checks or no, this doesn't. Yeah, I think, you know, we do a fair number of small checks as LP's, primary LPs, into funds. And I've been doing that for probably the last 10 years or so. So we've invested small tickets into about 40 or 50 fund managers. And when we're doing this at 500, we had started about 20 small funds within 500. Jordan's spot on.

Starting point is 00:59:25 It's very difficult to do diligence in the first three, four years of a VC's career. But I think Jason mentioned this on a previous podcast, and it's sort of the same math that I look at, which is what's the progression from pre-seed or seed to series B? And there's several rounds in between there. And you're not looking at it on an exclusively quantitative basis. Like everybody can get lucky and get one big winner here and there. But what you're looking at is proportional progression of the portfolio where you're getting consistently, let's say anywhere from 30 to 50% of your bets from pre-seed to seed, from C to series A, from A to B. And probably somewhere around Series B, you've got a company that's actually got revenue, got product market fit, and is progressing.

Starting point is 01:00:12 And not necessarily that that's going to be a great investment. But if I'm looking at early stage managers, I want to find out what's there. ability to sort of pick and or help companies from those early stages to some level of sustainable progress, which is usually, in my opinion, three funding rounds, but somewhere between pre-seed C to Series B is that progression. And if they can get at minimum of 10 to 15 percent of the companies, regardless of the quantitative outcome and TVPI, that's interesting. Certainly if they're getting 20 percent, you know, from C to B, that's a pretty good number. Yeah, that continuation strategy and that data was something I was introduced to going out for my fourth fund.

Starting point is 01:00:56 I had never studied it and really focused on it, but I did see that some of the larger LPs did look at that. And we had to have them not benchmark us versus seed funds. I was like, oh, no, no, no, we bring the inventory to seed funds. So at seed funds, our percentage looks really bad. But then when you compare it to other accelerators and pre-accelerators and pre-seed, it looks just fine. So each of those jumps, if you're doing your job correctly, you have a very low batting average if you're an accelerator. Because if you're an accelerator, you really are trying to work the power law. You really need to look for crazy ideas like Coinbase and Airbnb and Uber and Robin Hood.

Starting point is 01:01:37 You really need people who are trying to attack windmills. Like, you need the crazy lunatic founders to bet on. And you can't just be betting on, you know, all SaaS, you know, run-of-the-mill copycat product. You need outliers and you need to bet on crazy things. And those have just a very high attrition rate at the earliest stage, right? 80, 90% going to zero when you're running an accelerator, pre-accelerator. But you're getting it at low prices. So, I mean, I think they always have to balance that, you know, there's something we used to look at,

Starting point is 01:02:09 which I was calling like value weighted progression. And usually it was like, what's the round to round step up in value? What's the follow up on or survival percentage? And what's the dilution? And if you multiply those numbers theoretically, they should be better than one. In other words, if you're deploying a dollar, you should get better than a dollar's worth of value at the next stage. But it's also interesting math to look at for whether you should be doubling down or not. So like we did that analysis at one point, even though there's high attrition rate at the accelerator, you know,

Starting point is 01:02:39 the step up in round to round valuation, you know, is usually like 4x. Sometimes it's even more than that. So again, if you're getting in between one to two million dollar valuations and these companies are raising at a minimum of 8 to 10 million or even more, you have a really incredibly good step up in round to round value. And so if you get a significant percentage, let's say at least 30% and 40%, you know, you're getting a number that's, you know, far greater than one. And conversely, it usually means that that's not such a great,

Starting point is 01:03:09 a place to be making a follow-on bet. Because what we would typically see is that even with the attrition, because of a low valuation, we would get our best IRR check at Preceed in the Accelerator Program. That's not always true in less competitive environments in other places outside the U.S. That step up in round-to-round isn't as significant. So it might make sense to have more of a follow-on strategy in those less competitive markets. But if you're doing good job as an accelerator manager or as a seed fund manager, you should be getting your best IRA on your first check, in my opinion. Yeah, and just to build on that, it's the conversation I have with our RAAs, we call them, researcher, people we hire out of school, analyst, somebody who's done 500 introductory meetings with the founder over Zoom, recorded them and written coverage of them.

Starting point is 01:04:01 and then a thousand, you know, calls you get to associate level. So these are, and people can do it in less than a year. They can get to 500,000 calls in one year each step up. So we like them progressing quickly. And with that group, you know, I will ask them to advocate. And they write their deal memos. They advocate for companies. And we have that record for all time, right?

Starting point is 01:04:23 That they were saying, yes, we want to do this. And then I say, no, here's why. And then we have to live with that. But the framework I put into it when I'm asking them is, okay, we already own 7% of this company for 125K, call it a $2 million valuation. Okay, now they're going out of 10. In order for us to get another 7% would be $700,000, so to Dave's point, do we need to get to 14% right now? Probably not. What have they proven since they've graduated?

Starting point is 01:04:53 Who knows? But maybe we want to get to 10% ownership. And then I asked them for that 300K, would you rather do three more accelerator companies or two and a half? Or would you like to do... This Nelson is so smart. Would you like to do 12 more swings at bat at the 25K, 2.5%? And in every they come back and they're like,

Starting point is 01:05:13 I would like to do another 125k bet and I would rather do 725K bets or I'll do two 125 bets and two 25K bets. I'd rather have more shots on goal for my performance, right? So this is a very interesting framing. That's super smart that you do that. Yeah. So many people have that follow-on framework. They don't think about, you know, you have limited amount of resources.

Starting point is 01:05:36 You have a finite amount of bets that you want to make. Is the marginal amount of ownership you're going to get in this company worth it? You know, because you already have a bet on the table on this company. You really need to be buying 50% more relative ownership. I would say arguably 100% more relative ownership in order for that to really make sense. Because if the company's going to win, you've already got whatever ownership you've got. Are you sure you want to add a marginal amount of ownership in that versus like betting on something else or betting on five other something else's? Yeah.

Starting point is 01:06:06 And it really is a function of your deal flow. Maybe you don't have a better deal in your deal flow or maybe you have too many good deals. I find myself having too many good deals wanting to come to our programs. And so I tend to lean towards that. But I did come up with a framework that has taken me about a year to come up with to train the team on what I think is a likely winner coming out of the stage stage and what I think is a definitive winner. And now that I've codified that, we have a much better framework. So we do those two frameworks. Is it a likely or a definitive winner? Or would you rather make these more

Starting point is 01:06:40 smaller bets in the programs? And it's just changed everything. Because I steal memos into an AI. We'd love to see like three, four years of that. Okay, right. You're already thinking about it. I mean, this is a thing that like, That's got to be gold four years later, five years later. Well, I've also tagged the data. So we now, you know, every week, hundreds and hundreds of applications come in and 70 meetings, 70 calls, 70 call notes, you know, and the stuff. So, yeah, we are, you know, like the other day, I was just like, tell me how many marketplaces we didn't invest it. And they were like, 397.

Starting point is 01:07:13 I was like, email them all and ask for an update. I love marketplaces. I've made all. A lot of the money I've made in this life has come from Uber, Thumbtack, a lot of marketplaces. places in our portfolio that I've done pretty well. So I'm like, get me the marketplaces from the database. We don't have any deals? Great.

Starting point is 01:07:30 Let's go back to the deals in the database. And being able to pick and my obsession, and I've said it before on the show, I have two things I'm super obsessed with right now. We have the deal flow. We have the decision making. We don't need to compete to get in deals because it's seed and pre-seed. They're passing the hat most times. So really the doubling down strategy is really the thing I am most, and portfolio

Starting point is 01:07:53 construction, which is the same thing, essentially. Our doubling down strategy is everything for us now, because we know we'll have in fund for 250 names, and we just need to add, we know there's going to be some breakouts. We just need to know which 10. Which 5% will break out, and that's 12, 13 companies out of 250 will break out. Which ones are those? How do we know it's a breakout company or not? That's the obsession I have right now.

Starting point is 01:08:23 You know, I think there's a great article. I don't know if it's widely distributed, but Clint Corver at Ulu Ventures wrote a pretty interesting analysis on follow-on strategy. I think it was probably written about five or six years ago. And, you know, it really somewhat, you know, contrarian. I think a lot of LPs, particularly institutional LPs, look to see, you know, conviction, which I think probably induces more. follow-on behavior than the market should really be exhibiting. I actually think the default case should be you should not follow on in most scenarios. You're better off making a diversified bet on another company. And it's only in the very clear cases of strong growth and significant, you know,

Starting point is 01:09:11 marginal ownership that that follow-on bet really makes sense. Unless you're doing it out of a separate, you know, pocket or separate funds. I think from the LP perspective, they have exposure to 2020. managers and each of those have 20 to 25 companies. So they have 500 underlying companies. So they feel like they're capturing the power laws, but they want that alpha. They want the next Airbnb you put in 25% of your capital into that. They want that high outperformance. So there is some rationale there.

Starting point is 01:09:40 But if that follow on bet is based on... Again, it might be a good rationale for the L.P. Not for the emerging benefit. For the GP, yeah. For the GP, it's similar to a VC investing into a company. it ends up being an n equals one. And if you win, you win marginally. It doesn't really change your life.

Starting point is 01:10:00 But if you lose, you don't do another fun. So there is somewhat of a mismatch there. I think from the LP side, too, it's very funny. I've seen people who have shown me presentations that have said, you know, if I had just leaned in more to this company, which is what we now do, look at the returns I would have made. And I have seen people say, you know, if I hadn't followed on as much, which we don't do anymore, look at the returns I would have made. You know, you can be successful

Starting point is 01:10:27 doing it either way. I think some of the better returns we've seen have been from doubling down, tripling down. If you get it right, I think it works really well. And if you're able to leverage the kind of asymmetric informational advantage you may have, it can work really, really well. I'll tell you another concern is, you know, especially if you're investing across funds or if you're leading multiple rounds in a row, you know, are you propping this company up? Are you throwing good money after bad. And understanding that dynamic, too, I think, is something that's important from the LP side. Yeah.

Starting point is 01:10:58 If I could go back, I probably made, you know, 10 bets in each of the funds, first fund, second fund, third fund, maybe 20, where I wouldn't say they were sympathy bets, you know, but they were founders who really resonated with me as a founder and who convinced me, yeah, they were going to figure it out and I placed the bet. But maybe those bets would have been better into another new company. And, you know, that we've now figured out a way to communicate that to folks, that we are not the permanent source of capital for our companies and that we don't invest in bridge rounds.

Starting point is 01:11:42 We invest in companies once or twice and get to 7 to 15% ownership. and then we deploy capital into new companies. And once we explain that to folks, they were cool with it. They still might ask us, but I think a lot of GPs get caught up in loyalty to founders, which I understand. And I've been super loyal to founders, and I want to give them that support. But you have to have a portfolio strategy. And now we just say, hey, the fund you're in is fully deployed.

Starting point is 01:12:14 That's it. And you wouldn't pass the rigor of the new fund. because it's not growing right now, so we can't bridge you. That fund's closed. The new funds open. You'd have to have 3x growth to compete for those new fund dollars. And when you do, we're happy to have that conversation. But the company's sideways.

Starting point is 01:12:32 You've got to go find money in the market. I think that discipline is really important. It's really important. And you only get to that level of discipline, I feel, when you get to your third, fourth, fifth fund, and you have to face the scrutiny of LPs. or like, tell me about these re-ups. You know, tell me, you know, somebody like, Jordan, hey, I see you did these bets.

Starting point is 01:12:53 What was your thinking? And, you know, I got to pull it up and go to the deal memo, go to the Slack conversation. And okay, yeah, I made a mistake. That was a, that was a poor bet. I put bad money. I put good money after bad. You know, I made a bad bet on a startup.

Starting point is 01:13:07 Okay, we're all adults. But then that second or third bet, that's where you really have to start questioning, you know, do you have a good portfolio strategy? I don't think I had a great portfolio strategy in the first couple of funds. I think I had like the standard one, which was bet on a hundred, you know, bad on a hundred companies, hope for the best. By the way, Jason, you hit on something I think it's interesting, which is the ability,

Starting point is 01:13:31 you know, growth mindset, ability to get better and to learn and to evolve your strategy. When we talk about going back to, you know, how do we look at a fund, evaluate a fund one or a fund two when they're back in market, that is a part of it, right? Hey, I want to hear about the bad investments you've made. And what did you learn from? I want to hear about what you would do differently in your next fund and continue to see that growth. And so I think that's another element, too. I don't think anyone would be surprised to hear me say that there is, you know,

Starting point is 01:13:57 sometimes a little bit of ego in venture capital. And so, you know, to that extent, you know, when, I know, right, crazy. And when you can see a little bit more sort of humility and growth and ownership and like, you know, I can always be better and I can always get better. I think that is also something that we find good calling. Now, on to the lightning round of top three investments from each guess. Dave, go ahead. Well, I guess most of the investments we do are at the fund level and private,

Starting point is 01:14:28 so I can't really talk about which deals we've done that are great there. I can talk about the direct secondary deals we've done. So I guess three of those, Mercury, which a lot of people probably know, is startup banking and APIs for companies. And credit to Zach Coelius. I'm an LP in Zach's fund. Zach is really amazing. I've tried to hire him at least twice in his career, my career.

Starting point is 01:14:58 But he's ready a great fund. Mercury was one of his winners, and he helped us get into a private secondary in the company that was great, and we'd love to own more. So that one's doing great. Also great as a customer if you're a startup looking for banking services. Mercury has supported my podcast over the years, great company. Yeah.

Starting point is 01:15:23 Really supportive of founders. Another one that we're investor in as a company out of Germany and Austria called Gropius. Actually working with them on changing the name to greener.com. But they do factory automation and robotics for building prefab. multi-family housing, so condos and apartments. You can kind of think about it as like a Tesla factory for building condos. Pretty amazing company. The founders have both been involved in other public tech companies.

Starting point is 01:15:52 One of the founders was previously involved in Leverry Hero. The other one led engineering at Zolando. It's about 400 people. Half of them are software engineers. And they basically do programming on these robotic arms to build, you know, prefab housing, basically walls and siding very quickly. and their customer isn't the end owner or renter. It's the real estate developer.

Starting point is 01:16:18 And so they put together those walls and sightings, deliver them to the construction site, and then the real estate developer builds those houses a lot faster because they can just assemble them fairly quickly. And I think this is an interesting theme that I think we'll see in a lot of physical manufacturing companies is automation and robotics, you know, sort of improving the economics and productivity of physical manufacturing. In the same way, everybody's going gonzo about AI making software companies better and more productive. I think robotics automation is going to make a lot of physical bits companies more productive. And then last one I'll highlight, we've been doing a fair number of secondaries in Latin

Starting point is 01:17:01 America for folks who aren't aware of it. Brazil and Mexico are really big drivers for the Latin American market. but it's a pretty large overall market that's larger than California GDP and half the size of China GDP. A company we invested there is called Ricargapay that's out of Brazil. And basically, I don't know if many people know about this, but about two years ago, Brazil adopted a payment system. It's really driven by, you know, the central banks and the government over there called PICS. It's highlighted right there, P-I-X. in less than two years,

Starting point is 01:17:39 about 80% of the population is now using it broadly. It's kind of amazing how quickly the adoption has happened. So Ricargo Pay is basically a payments platform, kind of like a super app similar to maybe we pay in China that does a lot of things or

Starting point is 01:17:53 like grab in Singapore. And the, I guess I would say dirty little secret, but not so dirty. Latin American companies are very reasonably priced. There's just not a lot of, not a lot of VC capital in Latin America, at least not on the scale that you see in the U.S. or even, you know, maybe in Europe or India. And so evaluations are quite reasonable.

Starting point is 01:18:21 I think SoftBank had a big portfolio that was investing in Latin America many years back. It was about a $5 billion portfolio. For whatever reason, I won't get into SoftBank, changed their mind, pulled out of that. And the guy who was running soft banks portfolio in Latin America, Marcel Claray, raised a fund called Bicycle Capital. It was $500 million and is still investing in Latin America. So I think there's really great opportunities, not just this company. We've made three or four investments down there.

Starting point is 01:18:54 Brazil and Mexico in particular are really taking off, but the overall market for Spanish-speaking Latin America and Brazil, which speaks Portuguese is tremendous. Amazing. I'll go super fast. I have a little bit of a theme today about websites and people building websites. So this first one is called Motive. This company reached out to us.

Starting point is 01:19:16 It was like one of these seemingly boring businesses. It was a website builder. But this was a website builder for people who own dealers and dealerships. And it turns out, you know, these dealerships need. websites. They're incredibly complex to build. And a lot of commerce goes through them and the entire world is moving to buying online. And we invested in this company that helps these dealerships build websites. And man, is it doing really well? So there's Squarespace. We love Squarespace for general and, you know, building anything. But there are some websites that are super complex.

Starting point is 01:19:56 Long tail of websites. And we've found a number of companies that are working on that. Test Rigger went through Founder University and our Accelerated. We made two bets on them, I believe. And it's a generative AI-based test automation solution. People should be writing tests when they write code. They don't. And they're just taking that little narrow spot and trying to solve this problem. And then finally, Crepling is building a drag-and-drop whizzy-wig style editor,

Starting point is 01:20:22 AI-powered editor for building modern e-commerce websites. And so you can go into this. as you can see here and build workflows about registered users coming and then have them send an email, then offer a discount. So it's kind of pulling together offers and publishing and app building. Really amazing how this company has done. We made a small investment and then we watched them raise their prices. One of the great pieces of advice we generally have for companies is raise your prices. Same number of customers, triple your price, lose 10% of your customers.

Starting point is 01:20:59 Net net. You're now at $270. Let's say you're at $100 and you had 10 customers paying $10 each. You raise it to $30. You'll lose one. That's just fine. You're going to still do okay. And you'll lose your worst customer too. And you tend to lose the worst one. But I really like your sustainable living company here. We had an investment in a company that was doing modular housing and it was incredibly hard and seems like almost everybody who's gone up the sale has failed. But I do think somebody will figure it out and it's going to be a great investment. So I really would love to meet them at some point. Well done. I'll connect you. They've got a pipeline of business in Germany that's huge and we're trying to bring them to the U.S. Really, really hard business. And developers are really hard customers.

Starting point is 01:21:48 That's one of the things we learned is the developers, selling into developers is really hard because they want to pay the lowest price possible and then have the highest margin and sell at the highest margin. So their incentive is, you know, super, you know, to deliver the cheapest product and have the highest margin. What's the price per door? What they don't realize is like running of an apartment is the most, the cost of running the apartment is equally important for the person who builds or owns the thing. So your HVAC, your efficiency and energy, resistance to flooding and fire, which are the two biggest disasters in apartments and the biggest cost centers is floods and fires, even if they're contained. And so you should be incentive to use better materials, better age vac, better insulation. But the construction people are like, oh, screw that.

Starting point is 01:22:39 Just give us cheaper, cheaper, cheaper, cheaper. We want to buy this for $50 a square foot and sell it for 400 a square foot. You know, we want to open each door for the lowest price possible. It's like, well, the ongoing, you know, maintenance of these things also should come into play. Well, you hit on the part two of their business because they build digital building sensors into all those materials. So once they deliver them, there's actually a building operating system that the developers can run to measure all that as well. Which is super important. Yeah. To know that this unit's got a flood or this one's on fire, pretty important information that they generally don't have. Jordan, real quick, last three fund investments.

Starting point is 01:23:16 Yeah, go super quick. So the first two investments out of our recent fund, the one we literally just launched like five minutes ago are Andrews and Horowitz, who was a fund one investment that we've done. made as well, you know, long relationship there, love what they do. I think they're absolutely fantastic in that sort of upper echelon of top tier firms. I'll say founders fund kind of by default in the sense that we invested in their prior fund, which they ended up cutting half, given the macro, and I applaud them for it. They're one of very few managers I know who has sort of taken money out of their own pocket in a sense to become what they view as in line with the macro. And so some of that initial exposure got pushed to their next fund, which we are investors in out of our fund that we just launched as well. So those are the first two. And then the last

Starting point is 01:24:08 investment we made out of our fund one, which was last fall, I want to say, was 776. So, you know, Alexis O'Henian's fund, a lot of respect for, you know, what he's built there. And, you know, obviously that goes back to the first thing we talked about as he was with Gary at that initialized. And he was the co-founder of Reddit or the record. That's also, yeah, you're right. I know I was getting there too. Lest anybody forget, getting their tweet at a firm that he co-founded. Yeah.

Starting point is 01:24:41 Spicy. You know why it's so contentious, right? Because they're so little at stake. It's just a tweet, folks. People are starting to spill tea and shade over a tweet. I mean, how do they leave him out? He was the co-founder. Aye, aye, aye. He's incredible. Going back to the comment I made earlier about, like, being humble and gracious, I would put him in that camp for sure. He is just such a really, really good human being. And so those are, those are our most recent three.

Starting point is 01:25:16 Amazing. Awesome. Well, this has been an amazing episode, David. Thanks for hosting again. Well, done. Am I going to see you at the liquidity summit? David, are you going to make it? you will see me and I'm excited about it. I saw some of the guests coming there. Pretty impressive. So I'm excited. Pretty impressive. I need more LPs to come. It's going to be June 2nd, 3rd, 4th and 5th, but the main days are second and third.

Starting point is 01:25:38 I was right. The 3rd and 4th are like the content and activities days. The second is just a welcome dinner and poker. And then the Wednesday is going to be like a closing brunch. But I'm kind of making it. It used to be called Angel Summit. Now I just called it liquidity because it stopped being about angels and started being about the LPs and the GPs.

Starting point is 01:25:56 And we had, I just emailed all the GPs in our world, and I think 70 of them signed up. And so now I'm in the process of inviting the LPs. What are you want? You want foundations? You want endowments? I think a couple of each would be great. And then, you know, I'm trying to figure out what to do with this event. I want to do it twice a year.

Starting point is 01:26:15 I want it to be super constructive. So one day of full content, poker every night, second day, some content. and then the afternoon events. But I'm wondering if I should do what I Connections does and have speed dating. But I kind of find speed dating, I don't know. How do you feel about it, Jordan? If I was like, hey, here's five fund managers.

Starting point is 01:26:38 Do you want to sit with them? Or would you rather just meet them casually? I have always found that at those types of events when you try and do speed dating, you suffer from massive adverse selection. From my perspective, I'd so much rather just identify who it is ahead of time. and try and find a way to connect with them.

Starting point is 01:26:55 Yeah. I did like I connections. I went to I connections twice, and it was nice to set up meetings. They were double opt in. What did you say, Dave? I think you should facilitate that process before they go and then have the meetings that everybody opted into, double opted into there. But usually what I would say is the speed dating is a mismatch for like 80% of the dates.

Starting point is 01:27:22 But there's no reason why you could. couldn't figure that out ahead of time, in my opinion. Yeah. So maybe have the GPs have tables and let the G, the LPs come to meet them if they want to one morning. Yeah, I think if you've got like the GPs to give you like a one pager on their fund, maybe a 30, 60 second video if they want or a short deck. Oh, that's a good way to do. Send it ahead of time.

Starting point is 01:27:44 Oh, yeah. Let me. Here's a presentation on my fund and the deal memo. And then you could, if you want to meet, you meet. That's a good way to do it. Yeah. So I don't. Yeah.

Starting point is 01:27:51 There's a lot of. If I was an LPs coming. If I was an LP, if I got a list of the like one pageers on on these firms, I think I would start by prioritizing the ones that I'm familiar with, right, and say, okay, this is actually someone I've wanted to talk to or someone I haven't talked to in a while or whatever. And I'd go through the rest and say, hmm, this is actually really interesting or really compelling or whatever. And I love that idea, actually. That would be from my perspective. Fantastic. What do you think of the video?

Starting point is 01:28:14 You like the idea of a video? I just want to deal memo. I think videos are always helpful. I would watch it after if I like the memo. I would not watch it unless I like to know. All right, Dave. Do I get to come now? Sure.

Starting point is 01:28:29 I mean, you're here. So, of course. Where is it happening? I do it in Napa. This is the six year I've done it. I remember the seventh. I just did it because my book, Angel, came out, and a lot of angel investors are like, hey, I want to hang out. And so we would just do this Angel summit.

Starting point is 01:28:45 And it was originally, I thought maybe we'd get 50 people together. And then it's always been 125, which is the maximum most, restaurants in Napa will take. So I've tried to keep it to $125. I've got 70 GPs already. So I'm going to cut off GPs coming. And then I'm just going to have the other 50 slots be for LPs and founders can't come to it. And then service providers, we let them come if they buy dinner.

Starting point is 01:29:08 So if they do a 25 or 50K sponsorship, we give them one or two tickets and they just pay for the dinner, whatever. And so it defers a little bit of our cost if they want to do that. So typically banks or law firms or accounting firms or whatever, we'll. you know, they'll want to buy lunch for everybody. And so it's quite nice. But I'm trying to figure out a way to do it that doesn't become overbearing. Because I don't want it to become like a bizarre and haggling and hard selling.

Starting point is 01:29:35 So I like the idea of like more activities. Hey, we go on a wine tasting. We go to cooking class. You meet some people. You meet some people on poker, you know, or some board games will be set up. So you kind of more casually meet people is my goal. You know what's interesting. Mark Schuster did this for a while and it became so successfully stopped.

Starting point is 01:29:51 doing it, he would publish the list of all the LPs and GPs that are going and people self-aggregate. That could be another potential solution. Yeah. I will say, I have found the less you can make it like a conference, the better in my perspective. I think the more you can just have people organically converse and get to know one another, I think it's far more valuable. All right. Got it.

Starting point is 01:30:16 All right, Jordan. You're in. You're a fund of fun, so you should come anyway. Yeah. It would be great to have you. We're going to do a fun-to-fund panel. So you should be on that panel. Like, not panels.

Starting point is 01:30:25 We're going to have three fund-to-funds, give like a five to ten-minute, like, hey, here's how we think about the world and then have a roundtable discussion with the audience. So I'm trying to have it be just five minutes, 10 minutes of like, here's what I think is happening in the world. So it's like low-pressure presentation. Like, it could be one chart. Here's what we believe. And then the next person, here's what I believe.

Starting point is 01:30:46 Next person, here's what I believe right now. And then group discussion. and then audience microphones passing. It worked out really well in the last time. All right. Close this up, David. We went long. Well, it's been another great episode of the liquidity podcast for Dave McClure, Jordan

Starting point is 01:31:01 Stein, Jason Callicanis. This is your host, David Weisford. Thanks for listening.

This Week in Startups - Dave Mcclure & Jordan Stein on YC, "Spray and Pray", and Games VCs Play | E1923

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