This Week in Startups - Misaligned Incentives Between GPs and Founders with Altimeter's Jamin Ball | E2045

Episode Date: November 15, 2024

This Week in Startups is brought to you by… LinkedIn Jobs. A business is only as strong as its people, and every hire matters. Go to https://www.linkedin.com/twist to post your first job for free. Terms and conditions apply. Beehiiv. Power your newsletters with AI tools, referral programs, and ad network features—all in one platform. Get 30 days free and 20% off your first 3 months at https://www.beehiiv.com/twist CLA. Innovation takes balance. CLA's CPAs, consultants, and wealth advisors can help you get from startup to where you want to end up. Get started now at https://www.CLAconnect.com/tech * Todays show: Altimeter's Jamin Ball joins Alex Wilhelm to discuss VC-founder dynamics, fund returns, rapid fundraising, and its impact on M&A. They cover public vs. private valuations, startup liquidity, AI's influence, SaaS trends, and Jamin’s outlook on IPOs and exits. * Timestamps: (0:00) Jamin joins Alex to kick off the show (6:30) Alignment of incentives between VCs and founders (10:25) LinkedIn Jobs - Post your first job for free at https://www.linkedin.com/twist (11:54) Venture capital allocation demand and its impact (15:55) Comparison of returns between small and large venture funds (21:54) Beehiiv - Get 30 days free and 20% off your first 3 months at https://www.beehiiv.com/twist (23:23) Power laws in startups and venture capital's impact (24:19) Effects of rapid fundraising cycles on founders (31:33) CLA - Get started with CLA's CPAs, consultants, and wealth advisors now at https://claconnect.com/tech (32:59) Raising large rounds and long-term commitments (35:15) Venture capital's influence on startup M&A activity (37:38) Public vs private market valuation disparities (39:24) Future of startup liquidity and exit scenarios (46:06) Proposals for realigning venture capital funds and founder incentives (47:41) Impact of AI on startup growth and venture capital (52:20) SaaS multiples and cloud software market analysis (57:43) Software spending trends and startup optimism for 2024 (1:00:15) Procurement scrutiny in startup budgets and market differentiation (1:01:17) Promising companies and Jamin Ball's investment outlook (1:01:28) Expectations for IPOs and startup exits in the coming year * Mentioned on the show: Join Jamin’s substack here: https://cloudedjudgement.substack.com/ Jamin’s article: https://cloudedjudgement.substack.com/p/clouded-judgement-102524-misaligned Check out Altimeter: https://www.altimeter.com/home Follow Bill Gurlery on X: https://x.com/bgurley Subscribe to the TWiST500 newsletter: https://ticker.thisweekinstartups.com Check out the TWIST500: https://www.twist500.com * Subscribe to This Week in Startups on Apple: https://rb.gy/v19fcp * Follow Jamin: X: https://x.com/jaminball LinkedIn: https://www.linkedin.com/in/jamin-ball-49366137 * Follow Alex: X: https://x.com/alex LinkedIn: ⁠https://www.linkedin.com/in/alexwilhelm * Follow Jason: X: https://twitter.com/Jason LinkedIn: https://www.linkedin.com/in/jasoncalacanis * Thank you to our partners: (10:25) LinkedIn Jobs - Post your first job for free at https://www.linkedin.com/twist (21:54) Beehiiv - Get 30 days free and 20% off your first 3 months at https://www.beehiiv.com/twist (31:33) CLA - Get started with CLA's CPAs, consultants, and wealth advisors now at https://claconnect.com/tech * Great TWIST interviews: Will Guidara, Eoghan McCabe, Steve Huffman, Brian Chesky, Bob Moesta, Aaron Levie, Sophia Amoruso, Reid Hoffman, Frank Slootman, Billy McFarland * Check out Jason’s suite of newsletters: https://substack.com/@calacanis * Follow TWiST: Twitter: https://twitter.com/TWiStartups YouTube: https://www.youtube.com/thisweekin Instagram: https://www.instagram.com/thisweekinstartups TikTok: https://www.tiktok.com/@thisweekinstartups Substack: https://twistartups.substack.com * Subscribe to the Founder University Podcast: https://www.youtube.com/@founderuniversity1916

For venture capitalists to get rich, you need big company exits. For founders to get rich, you have equity in one company. There's one way for founders to get rich, which is big company exits. And so those paths were aligned, right? When founders got rich, venture capitalists got rich. And more importantly than that, it was kind of the only way to get rich. It's not to say that investors and founders now have opposite incentives, right? It's not like your failure leads to my success and their perverse incentives.

It's just more to call out the outcome is irrelevant. And now it's how can I max it? maximize my AUM, how can I maximize my deploy dollars? But that part of it can lead to suboptimal outcomes and experiences for founders. And we can talk about like, hey, how can these incentives of just deploy, deploy, deploy? How can that lead to outcomes for founders? And what are the implications for founders that they might not necessarily be thinking about before going into a fundraising process? This weekend startups is brought to you by LinkedIn Jobs. A business is only as strong as its people and every hire matters. Go to LinkedIn.com slash twist to post your first job for free.

Terms and conditions apply. Beehive. Power your newsletters with AI tools, referral programs, and network features all in one platform. Get 30 days free and 20% off your first three months at Behive.com slash twist. And CLA. Innovation takes balance. CLA's CPAs, consultants and wealth advisors can help you get from startup to where you want to end up. Get started now at clyconnect.com slash tech. Hey everybody. Welcome back to this week in startups. My name is Alex, and today we are going to talk about venture incentives. Now, this is an engine that the startup world runs on and having the incentives be aligned is very, very important. However, it does seem that as venture capital has grown, some of the incentives that we have depended on to understand the

industry have also changed. One investor put together a post that absolutely blew up over on social media and around the world of venture chatter. So I told myself, hey, let's get Jammin Ball to come here and tell us what's going on. And if you don't know, Jammin, he was an investment banker, then he worked at Red Point for about a half decade. And now he is an investor over at Altimeter. Jammin, hey, how are you? And how does it feel to be a celebrity blogger inside of our micro niche? I'm not sure if I'm quite a celebrity yet, but it's certainly fine. and thanks for having me here. I mean, I kind of view blogging

is almost a personal journal that I can make public, which it forces all of us and it forces me to really refine my ideas. But thanks for having me. Yeah, and just so everyone knows, it's cloudedjudgment.substack.com if they want to read your work.

And today we're going to rewind the clock to late October when you wrote about venture incentives. Now, if you're listening to this and you're already going, oh my gosh, that sounds incredibly boring. Keep in mind that benchmarks Bill Gurley said that this post, from Jammin could, quote, perhaps be the single most important issue for the entire venture capital landscape. So, Jammin, let's talk about two things. One, traditional incentives in venture. And then I want to work into what's changed. But breakdown for me the importance

of the two and 20 model and how back in the day VCs tended to eat well when founders did. Sure. So I think, yeah, first is defining the incentives. Writer said another way, how to venture capitalists make money. I think a lot of people have heard about the two and 20. But what does that, what does that actually mean? There's predominantly two ways venture capitalists make money. There's a guaranteed portion and then there's a variable portion. The guaranteed portion is what we call the two, the two percent. So venture capitalists will raise a fund and they will charge a percentage of that on an annual basis, which is called the management fee. It's usually around two percent. It varies over time and it steps down as you go, but call it roughly two percent on average. And those dollars

are used to pay salaries, pay rent, pay legal fees, all of that. Think about it as funding the operating expenses of the venture funds. And then in tandem to that, there's the carry, the 20%, and this is the firm's share of profits. And so when we make investments, you know, you hope, right, that those return multiples of the capital that you invested, and there's a share of the profits that the venture firms receive. That's 20%. So maybe let's make this concrete. Traditionally. is traditionally. That number is variable. Okay.

And it's variable, right? It's sometimes it's 25%, sometimes it's 30%, sometimes it's 15%. But I would say it's, you know, sidebar, it's interesting how fixed the incentive pool or the price of venture capital product has stayed given how much bigger it's gotten. You'd think as an asset class expands, as the supply of it expands, you'd think that would lead to pricing pressure. What's been interesting is it hasn't at all, which I think just speaks to the demand for the asset class, but maybe that's something we could put off to the side and revisit. But maybe

to make this concrete, let's talk about a $100 million fund that returns a 3x. And that fund, every year, the fund will collect 2%. So 2 million, 2% of 100. And that is on an annual basis, kind of independent of the investments made. And it usually lasts for about a 10-year period. Sometimes that can get extended, but typical life is 10 years. Now that $100 million fund is 3x, So we've turned 100 million into 300 million, which means we've generated 200 million of profits. And so 20% of those profits is 40. And so 40 million would go back to the fund, which is then kind of allocated based on who owns what percentage of carry within the venture fund from kind of your partners down to your junior most folks.

But if you think about that model, there's a guaranteed portion of the compensation, which comes from the management fee. And then there's a variable portion, which comes from, you know, did you make good investments or bad investments? Not that long ago, funds were significantly smaller. And so that... Much smaller. Much smaller.

So that guaranteed portion wasn't enough to, you know, really make you rich, right? I think the term that I used in the blog post was get rich, right? It's harder to get rich on 2% of a small number. And so as venture capital, it's like, how did you really make money? How did you get rich? Well, it's you maximize the carry. You maximize that 20%. And what does that mean?

It means for venture capitalist to get rich, you need big company exits. For founders to get rich, you have equity in one company. There's one way for founders to get rich, which is big company exits. And so those paths were aligned, right? When founders got rich, venture capitalists got rich. And more importantly than that, it was kind of the only way to get rich. And so there was a lot of incentive alignment. As funds have gotten significantly.

I'm going to pause there. Yes, please. The aligned incentives here are pretty clear because if a venture capitalist cannot get rich off of their management fees, the only way to do well was to have their founders really, really to excel. And if you're listening to this and you're thinking, you know, $2 million a year, that's a lot of money. Why couldn't you get rich off of that? Well, keep in mind that business class tickets to France are not cheap.

And also, you do have staff and there's a lot of legal work that goes into this as well. So you can burn through that money pretty quickly just on operating costs to run a complex financial instrument like a venture capital fund. So don't think that that $2 million in our example is a lot of money. It's cut up a lot of ways and there are expenses too. So not profit, certainly kind of a gross revenue figure. Jammer. Things have changed and funds have gotten bigger. And that's where your argument comes in that the aligned incentives between VCs doing well when founders do well, do well, has essentially broken. Yes. Yeah. And the purpose of all this too is not necessarily to highlight that there's

bad behavior in the venture markets. Like I think there is good behavior of funds that are large, but it's just a highlight for founders that the incentives are different. And I think it's important for them to realize that as they're deciding which funds to partner with over their 10-year journey. Okay, so let's take your example and let's 10-ex it. So instead of a $100 million fund, let's talk about a $1 billion fund to show people how the numbers kind of shift. Yeah, yeah, yeah. So in that billion dollar fund, you're collecting $20 million a year. And I think, again, the thing to keep in mind is this is guaranteed for a 10-year period, right? You know, people love SaaS businesses because they're recurring revenue, but you could churn in a year. You know, you can't think about this

this is almost a customer you sign that can't churn for 10 years legally, right? And so in that example, that's $20 million a year in fees. And let's say you $3x the fund. I mean, okay, those numbers also get significantly bigger. Now you're talking about $400 million of carry. But, you know, a reality exists where that $20 million is a lot of money now. And yes, it's still split a lot of ways, but it's now a lot of money and it's guaranteed, right? Three-xing a fund is really hard, right? That almost certainly puts you in the top quartile kind of for any vintage class. And so there's now an easy button to kind of get rich, which is raise as much money as possible. and you can get rich off that 2% off your feet.

That's not to say you can't get rich off the carry. You certainly still can. I mean, the numbers are still huge, but there is a path to getting rich where the outcome of the underlying companies in a fund don't matter. And it's guaranteed, right? And so I would say it's economically rational to go maximize the guaranteed portion of your income stream

versus the harder variable portion. And so what does that lead to? it leads to kind of what we talk about is, are you a 2% firm or a 20% firm, right? Are you a firm that's looking to optimize the 2% or optimize the 20%? And that's where the incentive alignment matters. Because, again, it's not to say that investors and founders now have opposite incentives, right? It's not like your failure leads to my success and their perverse incentives.

It's just more to call out the outcome is irrelevant. And now it's how can I maximize my AUM? How can I maximize my deployed dollars? but that part of it can lead to suboptimal outcomes and experiences for founders who are offered too much money at too high of evaluation, which is obviously negative, there can be negative for their business. And then maybe final thing,

look, we did our fair share of overvaluing and overcapitalizing businesses in 21. Like, I don't want this to be Jammin standing on his high horse, like yelling down at the masses as if I have this kind of crystal ball. You know, we are always trying to learn and better ourselves. We raised a larger fund in 21 and then raised a smaller fund.

And we can talk about like, hey, how can these incentives of just deploy, deploy, deploy, how can that lead to outcomes for founders? And what are the implications for founders that they might not necessarily be thinking about before going into a fundraising process? All right. Tell me if this sounds familiar. You hire somebody, they're not the right fit. Productivity drops, the team's momentum slows, it's uncomfortable.

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So if you're not looking on LinkedIn, you're looking in the wrong place. LinkedIn is packed with amazing talent. They're just waiting for you to post your job. And here's a cool bonus. LinkedIn uses AI to help you craft job descriptions now that attract the right people. I've used this. It's amazing. LinkedIn is the best place to get eyeballs on your job posting.

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they're getting into. but the thing that kind of confused me about the current state of affairs is twofold. One, the amount of capital that has flown, that has flowed into venture capital has gone up dramatically in the last, let's say, five years compared to historical norms. And I'm very curious about why all that capital came to play inside a venture, because if it was entirely predicated on low interest rates or ZERP, as we like to call it, then to me, it would imply that the era of these multi-billion dollar venture funds is behind us. doesn't seem to be the case.

So let's start with, you know, why has there been so much more demand for venture capital allocation than there was historically because that does seem to be one of the driving factors behind the incentive shift that you're describing. Yeah, I think the ZERP period

just accelerated a trend that was already in motion, which was venture capital, and this is not a phrase that I came up with, right? It has moved from and is moving from a high-margin cottage industry to a lower-margin mainstream industry.

15, 20 years ago, the venture asset class was much smaller. Funds were smaller and returns were pretty amazing. To be in one of a top 50%, let alone a top 25% fund, the returns were great. And so what did that mean? You know, anytime you have an asset class that is yielding a, you know, a really high return, that creates demand for that asset class and more dollars flow into it. And I'd say that was a trend that was happening for quite some time. And at the same time, you had a sophistication of the LP base, so people who give us money increased. And not just that, you had a globalization of the LP base. You had, you know, the emergence of single family offices, multifamily offices,

rich individuals. You have the emergence of private wealth platforms from big banks, right? You have individual people. You have international sovereign funds, right? You just had this rush of people who really didn't have a lot of exposure to the venture asset class prior to 2015, 2016, 2017, kind of all say at that point in time, hey, we need more venture, we want more venture. They started standing up venture teams, venture practices, venture programs to get into these funds, but they never could. The funds were too small, right? If you're going from a $500 million fund to a $550 million fund, you're largely...

Yeah, you're largely just re-uping with your existing folks. And so the access to it was hard. So all of a sudden, what happened in this ZERP period was you already had a lot of latent demand that all of a sudden now found a home, right? Because if you're going from a fund that's size X to a fund that's size 3X, you might be able to get there by having all of your existing LPs 3x their commitments, more likely than not, you're going to new investors, right, who didn't historically have access. And that's not to say it was all new. It certainly wasn't. You certainly had all the existing LPs also up their

allocations, kind of up their size because their public portfolios balloon, balloons, they got liquidity. You know, there's just a lot of money in the system. And naturally, when you have lower interest rates, dollars move further and further out the risk curve. And I'd say venture is far out on the risk curve. And, And so kind of benefited from that environment. But yeah, what's been interesting is as we've moved out of that phase, there's still a lot of demand, right? Like, I don't see that trend shifting, at least not in a big way.

Large funds have been able to raise larger funds. I'd say what's happened is that smaller funds have had trouble. First-time funds have had trouble raising second-time funds. Here's where I get a little confused there, Jammin, because if you're listening to your history of adventure, which, to be clear, tracks with my understanding as well. You and I weren't around in the earliest days of venture capital because we were little babies, but like, you know, we know the history. And small funds, big bets, you know, you hit a Google, you'd do fantastic well. And the returns were incredibly impressive compared to, say, public markets. But as these

funds have gotten larger, to me, like, it feels like the returns profile, by definition, has to come down. And that, to me, would incentivize people putting money into, to smaller funds. But you're saying here, and I've heard this from other folks as well, smaller funds are really struggling. So to me, it feels like there's a crowding into the funds that probably have lower IRR targets or kind of rate return targets, just given their scale. And that feels bonkers to me.

So help me understand why small funds, huge returns are not doing better in this market than the big kind of more P-E-ish funds. Yeah, man. Okay, lots to unpack there. just a couple points off the top. One, a lot of LPs have gotten a lot bigger as well, right? And they just need to write a $100 million check. You can't write a $100 million check into a $400 million fund.

You're just never going to be 25% of a fund's LP base. And so you just have to hunt larger funds. And so you have the emergence of LPs who only want to write really large checks because they just need to move a gross tonnage of dollars. Then I'd say, you know, there's another thing, which is there is this whole, I mean, the state private for longer. trend has been going for a while. And what does that mean?

It means you have world-class companies who are appreciating significantly in the private markets, right? It wasn't that long ago that a world-class IPO, a Twilio, a Mongo, a HubSpot, a Zendesk was a billion dollars, right? And those companies entered into the public markets at a billion dollars in valuation. And I think they all, I might be wrong, but you can check me after. But, you know, they all appreciated from like a billion to where they are today in the public markets, right? Even if it was $5 billion, the appreciation would still be incredibly material, whereas now I can see a series C for $2 billion.

You know, so the numbers certainly have changed. And not even just that. You're seeing companies like Stripe, like OpenAI, like data bricks, like Canva, like others that, you know, don't just get to $4.5,6. They get to $20, $20, $50, $150, $1.50 in billion. And so what does that mean? It means there are world-class companies in the private markets that can absorb really large investments and still appreciate and value. The downside of that is that's not a very value. to your everyday retail investors, right?

That's only available to venture capitalists and ultimately the investors in those venture capital funds. But I do think that there is a world when you can invest at the gross stage in a very profitable way. It just has to be very concentrated into those few companies that truly matter. Because the way I think about it, you know, ultimately venture will always be a power law game, no matter if you're a seed fund or a PIPO fund. The only way you're going to have top quartile returns is if you have power law outcomes.

So the question you have to ask yourself is like, how can I generate power lot outcomes at different stages? Here's why I think about it. At seed stage, there's maybe this many companies that could, you know, give you a power lot outcome. Series A, this many, B, this many, C. You know what it goes down?

There's a smaller, smaller number of companies that can generate a power lot outcome as you get later and later stage. And so I do think you can pitch a fund that is a large fund that will be extremely concentrated. It won't be diverse, right? It's not this, hey, let's go,

build a basket of 30 companies, it's let's go build a basket of seven and put hundreds of millions of dollars into every single one of those investments. And that is the way that we are going to drive alpha above kind of the median returns. I don't necessarily think that's how most large funds are approaching the market. And so I think what naturally happens is you get bigger and bigger, you just build more of an index. And what happens when you build an index, you start to hug the median. Yep. And so I think it gets harder to generate outlier returns at scale in venture funds, unless you are more concentrated, just because naturally you'll hug the index.

But I do also think you have a class of LPs who that's the product they want to buy. When you're putting a $300 million check to work, you're not necessarily expecting that to 10x. You'd be happy if you hugged the index and was slightly better. Right. And so that's kind of the promise.

And so what does that mean? It means as the world has now moved, again, back to this ZERP period, people move out the risk curve. As ZERP reverses, you move in the risk curve, the challenge with second time funds, third time funds, everyone knows,

hey, smaller funds are more likely to get you that power law outcome. You're investing in risk your businesses, right? But with more risk comes a greater potential return. But the challenge is, you know,

you're raising fund too. You just don't have data, right? Where are you good? You know, the company's in fund one, you've, you know,

have two years of marinating and we just don't know. And there's just this, hey, this big fund, and I think it's also important to call out, you know,

big funds only have the right to get if they have a history of success, right? You had a history of success over a decade, two decade, three decade period that gave you the right to raise a lot of money. And so you have made money for LPs in the past. You're a known commodity. That is the safer place.

You know, of course, the natural question is you made money in a smaller fund setting. Can you also make money in a larger fund setting? But the question a lot of folks are asking themselves who are investing in these funds is what's more likely? Someone who I know has made money some way, but is now trying to make money a different way. but there's lots of parallels, or someone who, like, there's just maybe not as much data on.

Yeah. That's riskier, right? You know, and who's not having trouble raising a second time fund or first time fund, right? It's folks who maybe were at one of these large funds and then kind of broke off to start their own fund that had a personal track record and a personal history and just,

you know, they were personally underwritable by LPs. But I do think there was just this, you know, whooshing coming out of the venture market of, maybe some of the fast money that entered in 2021. That wasn't quite sure. I think when you invest in venture from an LP standpoint, you really have to, you know,

smooth your vintages, right? You can't just pick, I want to invest in 2024 and this one fund. You should say, I want to invest in venture. I pick this manager as the manager that I want to back, and I'm going to back them in 24 and 26 and 28 and 30 because just like funds are driven by power law outcomes, I think funds over a period of funds are driven by individual power law funds, right? And so across five funds, you might have. one fund that makes your investment in those five funds worth it. Like, it's all, it's all kind of

a power law game. We switch to Beehive, and it has been huge for this week in startups. We have this Twist 500 newsletter I've been working on this entire platform where we're trying to find the 500 most important private companies. So twist 500.com and we've been using Beehive for this email newsletter, Beehive, B-E-E-H-I-V. It's a service that's built for growth. It's a service that's built for growth. And when you're doing an email list or a podcast, you want growth. And they've baked it into it. Beehive was co-founded by one of the minds behind Morning Brew. You know that incredible newsletter. Well, you can get access to the tools that helped build Morning Brew to millions of readers. And if you're interested in making a little money with your newsletter, Beehive can do that too,

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Great job to the Beehive team. We really love the product. I quite literally tweeted out Power Laws, rule everything around me earlier today in response to the fact, I think it was like top 25 podcasts, get like half of all downloads or something like that. PowerLoss, if you don't know what we're talking about, Google it and learn because it's incredibly important.

But to summarize, companies are staying private longer. Overall demand for venture allocation went up. And because funds that were already at scale had earned that right because of a track record, they're able to absorb more capital and returns expectations have come down. Okay. Yeah. That explains the capital wave that we're describing.

Now, let's turn to the founders. One thing that you said was the old model kept venture capitalists and the founders they backed in line or aligned because they were together for 10 years. Now with a faster fundraising cadence and a faster deployment cadence and more of an index approach, as you mentioned earlier, founders can get a big check and then be effectively left in the lurch if they aren't one of the ones. of those absolute outlier companies. Tell us about that dynamic.

And then if you could, Jammin, how often do you hear from founders who have been essentially left by the side of the road by their prior backers? Yeah. I mean, I think, I think that kind of happens all the time. And again, that's probably like a trend that was just made stronger in the 2021 period. But it is an issue, right? Like there was kind of the, you know, the cottage industry days of venture capital where you were a true partner through thick and through thin.

And you had eight boards that you were on. and you spent a very real amount of time with every company that you were on the board of. And that was a real responsibility to work with companies at a board level. You know, now as funds gotten bigger, there's just a reality that you just have to make a certain number of investments. Like the only way to deploy that dollars, again, I think unless you're deploying it in this really concentrated growth strategy, you just have to make a lot of investments. And there's just like limits of time, right? If you're sitting on 30 boards, like there's just no way you can spend a lot of time with every individual company.

you know, the model becomes more of find company, invest in company, then find the next company. And it's more about deploying the net new dollar versus optimizing the existing dollars that have already been spent, right, or invested. Spent sounds too transactional. But I think that's just a reality, right? Where at the end of the day, again, from a purely rational standpoint, if there's going to be a few things that really matter, you should spend all your time on those few things. Yeah. But that leads to suboptimal outcomes for founders because at the end of the day, like if your company is crushing it, probably don't, I mean, not that you ever need your venture capitalist, but like, you know, you need them less.

You probably have less questions for them. You probably have less challenges that you have to deal with, less one-off things that come up. And you're kind of on, you know, you're not on cruise control. You're doing a ton of work, but like you're just, you're operating well absent to your board. Right. You don't need training wheels if you're already going really fast because you've got good momentum. Yeah, when companies are struggling, it's when you, again, air quotes, need, right? More of that, that board.

It's how do we handle the few. future of this company? Should we sell it? How should we go about selling it? Should we shut it down? What are the implicated? You know, like, there's just a lot of other questions that I think the benefit of an investor board member can be quite helpful. But, you know, again, that's probably the time you're less likely to get that attention and time. Just given the nature of you're on so many boards, and there's only so much you can individually do. So I want to ask about like what this means for for founders today who are going out and approaching the market. Now, fundraising is always difficult unless you're incredibly lucky and doing incredibly well, at which point, none of this

advice applies to you anyway, so put those aside. But if you're a founder out there and you're looking to raise capital, let's say seed through series B and you're looking at funds and firms that are a variety of sizes, what advice do you give to founders in terms of sizing up what type of firm is the right fit for their company and their approach? Yeah. Look, I would say, I don't want the takeaway to be like big fund equals. bad, right? It's just more about like, what are you getting from your partner? It's not just the firm, it's the partner who's at that firm, like, how committed to your success are they? And there's lots of different ways to answer that question. There are a few important things to also consider, right?

Again, let's think back to one of the incentives of large funds is to deploy them so you could raise the next big fund, right? You kind of become a machine. And to go back to why that matters, if you raise another billion dollar fund while you start another $20 million a year, 10-year timer, you get a couple of those going and suddenly you're just flying on your jet and chilling and doesn't really matter what the stock market's doing. Sure. Yeah. If you're, yeah, I mean, these fund stack fees, right?

When you're, when you raise fund three, you are still collecting fees on fund one and fun two. Those don't stop. And so the more you raise, right, the more fees you generate. So what does that lead to? It can lead to situations where your primary KPI is deployment. Hey, I don't want to deploy 50. I want to deploy 100.

Yes. You've seen round size. is balloon, you know, are companies growing faster than they ever had? Yes. Are they growing headcount faster than they ever had? Yes. Could they then absorb more capital than they ever have? Yes, but I would say the magnitude of which rounds have increased is far outpaced the, I'd say maybe the trajectory of kind of company growth. And so you might set out raising a $25 million series B, but you'll get $50 million series B offers. Now, why is that? Is it actually good for your company? You might say, wow, great, it's more money. Yes. At a higher valuation, yes.

This firm has the deepest conviction in me. But the reality is, is their incentives might be just to deploy more money. And it's not necessarily that they have all that more conviction in you. It's, hey, in a power lot outcome, it doesn't matter if I pay 100 or 200, because if this is a $20 billion company, that's a power lot outcome. I just need to deploy more money. Right. But, you know, again, and what lesson have I learned?

Gosh, there's a lot to unpack coming up here. Coming out of 21, like, overcapitalizing and overvaluing a business really can create risk. What are the benefits of it? It might be less... The founder, because people might think, oh my gosh, more capital, more capability, more flexibility, more time, but higher valuations that come with larger checks, come with their own expectations,

and you can end up essentially stuck. And my rejammin is that some companies that may have done better, essentially were overcapitalized to the point in which they kind of like, kind of choked on their own spit. I'll give you a couple examples, right? Which is generally what I like companies to do is raise a round, hit milestones, raise the next round, hit milestones, raise the next round. Hell yeah.

By raising a lot of money at a much higher valuation, what you end up creating is this structure of raise a round, hit four milestones, raise the next round, right? Because ultimately, you may be able to raise off of hype and you may, you know, the good times may keep rolling, but, you know, at some point it might shift. And then you'll need kind of underlying business momentum and fundamentals to justify an upround. Startups are hard, right? They're fraught with risk.

They're fraught with challenges. and kind of stacking four milestones in a row is hard. You might hit a road bump at milestone two or three. It might take you longer. It oftentimes does. But when that happens, if you're staring down the barrel of like a really high valuation, you know you're not worth today,

it just kind of creates existential questions for the execs, for the employees, hey, are we ever going to grow into this valuation? Oh my gosh, like, we're not a rocket ship anymore. What's going?

I got to get off. And it just kind of, when you raise these big rounds at big prices over and over and over again, it kind of creates, I don't want to call it an illusion, but it creates an illusion that, hey, this is a just, it's going to the moon. And companies move from hiring missionaries in the early days, people who deeply believe in what the company is doing,

the problem they're solving the product, to mercenaries. Hey, this company is a rocket shop and I'm going to make money on my equity. The challenge is you hire a lot of people who that's why they join. When you then hit a road bump, or two or three, and you will, then people start to question, oh, wait a second, we were raising at 3x markups every six months, every year. and now all of a sudden we're not, like, maybe I was wrong, right? I didn't join the company with deep conviction, which means I'm going to leave the company

with loose conviction. And then you hired all these people, you trained them up, people leaving, those attitudes are infectious, there's inertia to it. You know, Jammin leaves. And I talked to Alex, oh, hey, Alex, like, you know, I was reading Jammin's cloud of judgment. And he says software companies are only with eight times revenue. If we apply that multiple to our business, you know, we're at 80% discount to our private. We're never making money.

Like, we got to go. It becomes infectious. And you hired all these people for the wrong reason who then leave. And it's just, it creates a lot of turmoil that you have to come out of. All right, everybody, welcome back to the program. Stephen Estes is with us again. He's a principal at CLA, they're a professional services provider. They specialize in CPA, tax consulting, and wealth advisory.

His areas of expertise lie in VC-backed startups, VC funds, high-growth startups with complex tax issues in multi-state and international filings. Welcome back to the program, Stephen. Hey, thanks, Jason. Appreciate it. The last couple of years, it's been a little bit rock. and startup land after the bubble burst, post-Zerk. Tell me, what are founders sweating right now? What's keeping them up at night? I'll take the low-hanging fruit here and say funding. Before the pandemic, VCs were just printing money. And the last four years after the pandemic

have been a bit of a roller coaster in terms of capital availability. And I think things tightened up right after. And then in 2022, 23, capital seemed to open back up. Now we've got inflation and interest rates are higher. So we're kind of back in a position where money's tightened up because investors can get a good return someplace else. Gone are the days when an IV League degree and an idea on the back of a bar napkin would get 10 VCs lined up to invest in a seed round. Absolutely. They're being asked to do more with less and anything they can do to defer the need to raise again for as long as possible because the valuations out there just aren't what they used to be. All right.

You need a trusted advisor. Tax is accounting. You don't want to play games of this stuff. Get it right. Get a great partner like CLA. Go to CLAConnect.com slash tech and let them know. Your boy, Jake Al sent you. Once again, CLAC connect.

com slash tech. And this is always a conversation I have with everyone, which is when you raise a round of venture capital, you're implicitly committing to something. And what I mean by that is generally, like raising rounds and especially raising big rounds, it closes a path for an exit. Let's say you raise $100 million as a series A company. The way cap tables work is venture dollars invested going to primary shares, which means primary shareholders get paid back first on their. investment prior to everyone else in the cap table. That's founder shares, that's common shares, that's everything. So if you raise $100 million pre-product market fit, that means if the company sells for less than $100 million, nothing will flow through to anyone who's not a preferred

shareholder, which means you have closed that exit path. The counter is, if you're a founder, you might own 30%, 40% of your business at Series A. If you sell that for $100 million, that could be a $40 million payday. Like, that's life-changing. That's massive. But that path is no longer on the table if you raise $100 million. You have to, you are, you are implicitly committing to the next big outcome. And one of my big challenges with the big fund dynamic is big funds are driven by power laws. What matters to my fund, what matters to all funds are, are you a home run, or are you a zero? That's really all that matters. And even the in-betweenes don't really matter. Here's the irony of venture funds. If I run a fund that gets to a 3x return, if I have an

individual investment in the fund that returns a 3x, that individual investment is actually irrelevant, because I guarantee you, if that 3x investment was a zero, the fund would still be a 3x because the fund got to a 3x because of the 30x deal, the 40x deal. And so the middle outcomes, again, I don't want to say they're irrelevant. They can all be accretive, but they don't matter in my ultimate goal of kind of delivering a top quartile fund. But that's important to call out because the middle ground outcomes can be especially meaningful to founders and employees.

Yes. But this is just this world where these big rounds, again, it is shutting a lot of of those middle ground doors. And I don't think oftentimes founders realize that, hey, we have just implicitly shut that exit path door. And now we're playing the same game as the venture capitalists as boom or bust. The difference is, as a founder, I have one bet I get to make. It's my company. You know, venture capitalists get to build a portfolio. And they're getting the 2% the entire time. But I want to take what you just said and apply it to a theme we've been talking about on the show a lot, which is the startup M&A dearth or just the lack of access that we've been

seen. And you mentioned IPOs being delayed and that's a known phenomenon. There's been a lot of commentary in the, in the venture world, startup world, about kind of who's to blame for the lack of M&A essentially. And I know a lot of people have perspectives on Lena Con and so forth. But it seems also that venture is partially to blame because if they are putting too much money into these companies too early, closing off doors, well, there go the singles and doubles to use the classic baseball analogy

that some people in the venture world really seem to care about or covet. So, you know, as part of the lack of exits, just venture capitalists overcapitalizing early stage companies. It can be. And it has two impacts here. Like, first, let's talk IPO markets. Second, let's talk M&A markets.

Sure. You know, everyone likes to say, are MNAid markets open or are they closed? Like, I kind of take a different perspective. They're always open. The market clearing price just varies. And like, you're either willing to take the market clearing price or you're not. One challenge is all of these companies are, you know,

again, of all the unicorns, you know, there's maybe a 1300, I saw, read some article, you know, 1,300 private unicorns. Yeah, like, you know, I'd probably wager 5% or less of those unicorns, like, will ever actually, like, exit at a price greater than, like, what they raised in a ZERP round, right? Like, it's a really small number that will. What's one reason people think the IPO markets are closed? You raise around at $5, $6 billion, but your public, you know, if you were public today, you were $2 billion, you're like, I don't want to do that. Maybe you're boy. board doesn't want you to do it, right? Your board doesn't want to take that mark. Your investors don't want to take that head. Hey, just keep growing. Eventually, you'll be worth more. You'll grow into it.

But if your last round was a billion dollars, maybe you go public at $2 billion. You could double your last round price. There's no employee hit. There's no morale issues. You just doubled your valuation in an IPO. But if you raised it $6 billion, you don't want to go public at $2 billion. That's a down round. Your investors might not want that. You know, there's bad for everybody involved. It looks bad. It's momentum issues. And so, you know, I think one of the reasons don't see a lot of these IPOs is that there is just a market clearing price people don't want to accept because you can raise it 30 times revenue in the private markets and five times in the public markets. And there's just a big valuation gap there. And that'll change, right? I think

today the public markets are placing a premium on platforms, right? It's, hey, have you proven you have hit escape velocity and you have staying power versus are you a point solution that might have a zero terminal value five to 10 years from now because you're disrupted? So you have large companies that are successful companies, like a confluent or a Braz or Rubrik or, you know, I'm just trying to think of other IPOs like, you know, solid, very good companies that just don't trade at

big multiples, right? And so for every I mean, I, I, you know, off the top in my head, I think they'll trade it less than 10 times revenue. I might be wrong, but, you know, I think they're all less than 10 times. That feels right, especially Braise, which was a 20, 2022 IPO? It was very reasonably, yeah. Yeah, and so it's like you have, you have really good companies that are

growing well at scale, but they're not a billion dollars of revenue plus. Yeah. And I think there's just this question. And, you know, the public markets today are placing a premium on large companies. What are startups, right? They're not going to be a billion dollars of revenue. They might have 200.

So the market clearing price today for a subscale software company, it's just a huge delta between what you were able to raise that in the private markets. And so that's a really tough pill to swallow that no one wants to. But how have we ended up still here? because I feel like everything you're describing right now is not newly true. Like this has been a multi-year situation in which we've been staring at the same gap

between public multiples and private valuations. And I'm just sitting around going, surely eventually people are going to have to bite the bullets, swallow the poison, take the market clearing price and get out. And it turns out the answer is, no, not really, because we're just sitting here. So, Jim, when does, does there come a point when things break

and then the logjam does release, or do we just keep adding tension to the spring until it explodes? I mean, I don't know. I think there was probably a normal amount of like startup liquidity that, you know, if you were to graph it over time, you know, it was probably going up.

But the reality is that it wasn't going to exponentially change. And so we started funding companies as if the exit environment would fundamentally change. And I think the reality is, is we're just reverting to the mean. And I don't think the log jam ever breaks. I think, look, like, rates are going down, markets will come back. Maybe there's a new regime on the government and M&A picks back up.

But, like, we're not exponentially picking up. And so I just think the reality is there are a lot of companies that were overfunded that shouldn't have been. And there was a lot of money that was lit on fire that we're not going to see back. Right. But go back to our point about how large funds with brand names can observe a lot of capital and are staying large. Yeah.

And the fact that we are overcapitalizing startups and ending up with valuations that are often unpalatable to public markets. Yeah. To me, that just seems like a recipe for more of the same. And so I wonder why isn't there a movement? And I know the answer to this, but this is rhetorical.

Why isn't there a movement among VCs to build smaller funds? Yeah. That can do better not only for themselves on an IOR basis, but also to help founders capitalize correctly and have exits. And the answer is essentially fees to your overall point, but it drives me nuts. Yeah. It's incentives. And I mean, just think about it. Yes, let's say you had a big multi-billion dollar fund.

You could get smaller, but you're going to have to lay off a bunch of people. You're going to have to deal with reputational damage. Like, it's the same reason it's hard for companies to take down. I mean, this is so funny. I was just about to say this. Venture capitalists, or I was like, oh, take the down round, take your medicine. Like, it's not a big deal. And they're like, but it is a big deal.

It's the same thing for venture funds. Like, there's just, you know, imagine the headline like, oh, you know, this fund raised at like 20% of their last fund size. Like the appearances, you're losing momentum. The appearances you couldn't raise. Like, even if you chose that, there's just an appearance of it. And then the reality is, is, you know, if you raise a fund that's, you know, a fifth the size, like, you don't need the huge team that you had to deploy the fun 5x is big. And so you're going to have to lay people off and that's hard.

And so, like, there's just inertia. And when the inertia allows it to continue, if you're able to raise it, you know, I think Bill said this. It's like, it's hard to point to like one individual constituent to say like this person was at fault. Was it LPs? Was it founders? Was it someone else? Was it the Fed? Like, it's hard to point to one individual constituent.

Yeah. We all just kind of got here. Right. And now that you're here, then the question is, what do you want to do? Right? Do you want to take your medicine and it's painful? Like, or do you just kind of want to stay the course? So essentially, the same problem that we have with these unicorns that are stuck somewhere at a, at a really

let's say a fraction of their theoretical worth and venture capital firms that have become very large and are used to eating well off of accretive AUM, they both are not really incentivized to change the status quo, so we're going to end up with, oh, okay. That's, but yeah, I mean, it's even different, right? It's like, there's not a down, I mean, the downside for the companies is like, you're in a zombie march, right? And you're like, slowly going to zero, but you have a lot of runway. Isn't that really bad? Like, that's bad. No, no, no, this is what I'm saying. That's bad, But, like, that doesn't happen. That doesn't exist for venture funds.

Oh, oh, oh, I see. It's more painful for the founders. It's more painful. Yeah. And so, like, there's actually, you know, like, if you, you know, this term zombie gets used as a lot. Like, if you're like a zombie gross-age software company, like, you're not able to raise more money.

You just can't. No one wants to. Or they will, but at a massive discount or with tons of structure. As we've kind of said earlier, there's still a lot of demand for large venture funds. And so, like, there isn't a zombie venture fund. No, no one's going out there and say, we're going to back the companies that are only growing at 17% a year. Yeah, like there's just like everyone still wants, you know, again, I say this holistically. It's not this black and white, but like there's still a lot of demand for very large funds.

You know, and because it is this power lot, because companies are staying private longer, because there is more value to be captured in the private markets than there ever has been before. Now, individual firms might take different approaches to that, which either put them in line or out of line with founders' incentives or with LPs, desires for returns. But right, the LP environment is also changing. You have a whole new class of LPs that have different return expectations that have a different cost of capital. And so like the, you know, the checkers game has become chess right in some ways. But yeah, I don't know.

It's a hard to know, like, what's the forcing function of this changing? I don't know. I have one idea. And I know that if you are a partner in a venture capital fund, you are expected to put some of your own capital into that vehicle. Skin in the game, again, aligned incentives. if your own monies in the fund, you're going to be even more careful with it. So I'm curious if the percentage of AUM on a perf,

but just percentage of new fund that partners put in has changed. And if so, has it gone down? And if so, by how much? Yeah, you know, I honestly don't have tons of insight into this. Maybe just for the audience, what Alex is talking about, it's what's called the GP commit, which, you know, typically says, you know, if you raise a fund of size X, the GPs, all right, So the investors in the fund will contribute one to two percent of that.

And that's, I think, historically what it's been. It's about one to two percent. So let's go back to that $100 million fund. The investors at the fund are going to, of that $100 million are going to contribute one to two million. And oftentimes that is split proportionally amongst the different kind of seniorities of the venture fund. But again, let's go back, right?

That used to be very significant. Now you have a lot of folks who have made a lot of money. And so while, yes, the dollar value of that GP commit has gone up, so has the net worth of the people putting it in, right? And so it's like on a relative basis, it might actually be a smaller percentage of their net worth. Right. Because again, historically, like there are financial products. It's like cap call lines, right? Like, you go to, you know, a bank and you have to take out a line of credit to fund your cap call.

Like that's, you know, like, that's very committed. Like, you're literally taking out a loan to fund your capital commitment to the fund, right? Like, you better hope those investments work out because now you have a loan. Whereas now it's just a little different. friend, I think everyone is, the industry has gotten bigger, the industry has gotten richer, and I don't know if the percents have changed. Again, I don't have tons of insight, but they've certainly lowered as a percentage of net worth. And so, well, then I think to solve then, we just need to tune that up because, because the more of a fund that a VC owns,

the more likely I think they're going to be willing to put time in to save companies that might not be that grand slam that you're looking for, but it might be a triple. And you certainly do. You certainly have funds that have a larger portion of the GP commit. But what I go back to is like, who's going to mandate that? Obviously, the LPs want that. But again, let's think about a rational actor. Why not put zero dollars at work and guarantee a ton of money? Like pure economic capitalist animal, right?

That is probably the preferred path. But who's going to mandate that? You know, back to this supply demand. There's such a wall of demand for the venture asset class. You as an LP might say, hey, you know what, jamming 5%. GP commit needs to be 5%. Yeah. I'm not investing unless you put in 5%.

I say, okay, that's fine. I got 10 other people who are willing to do it at 2%. And like, that's just supply, you know, it's the supply demand curve. Like there is just a demand. Okay. That is willing to absorb all the supply at the price. Venture is selling, which is 2 and 20 with this, you know, maybe call the GP commit as a, as a component of that. Okay.

I figured it off. So the, the question of who's to blame? The answer is effectively nobody. It's two things, I think. one at that start and one at the end. Big wall of capital wanting to get into venture capital funds. It's rational for VC funds to raise money and then deploy it. We both agree.

The problem is there's just not enough outlier companies built each year to absorb that amount of money. So as long as the demand stays high, VCs will be rational and there will be distortion on the founder side and delayed access and so forth, as you've discussed. But until you can tune up the number then of breakout, outlawful, liar home run power law companies to back, we're going to end up, I think, still here. So then the question jamming becomes, what changes first? Do we get more outlier companies first? Or do we get a decrease in the wall of demand for venture allocation? That maybe is the right question to ask. And look, this is why it's so hard to answer. Like, I think, especially with this wave of AI, like companies, let's talk about open AI, like, however many billions of revenue they've got to in

like a couple of years, like, that is mind-blowing that you can have a company scale that quickly. Like that's just, it's mind-blowing, but you're seeing companies grow faster than they've ever grown. The size of the prize is probably bigger than it ever has been. I mean, again, go back. It wasn't that long ago where a Blockbuster IPO on the software side was a billion dollars. And so all of that is true, but it's still true that maybe the number of companies that are outlier isn't greater, but the size of the price, if you're in one of them, is far greater. And so then it just leads to this interesting question of, again, back to like that funnel I draw, there's just a, decreasing number of companies that are outliers at every stage, if you have a huge fund that's

going to be balanced, you would just have to absorb companies that aren't outliers. Because let's say you're a series D fund, and I don't know, I'm going to make up numbers. Maybe there's six companies a year that really matter at that stage. If you have to invest in 15 companies, it's like, you could have 100% hit rate and get every single company that matters. But like every incremental company you invest in is going to be dilutive to your returns, which is why you kind of, Either you are going to, you're going to further concentrate as you get later stage as an investment firm, or you're just naturally going to have to widen the aperture, which will force your returns, which will be dilutive to your returns, because there's just, there's only so many

companies that matter. And the reality is no one's going to be in all of them. But I go back to why do big funds get bigger? It's like, well, the big funds have a lot of influence. They have a lot of brand. They have a lot of reputation. It's who the best companies at those breakout stages want to work with. And so it's kind of this like recursive loop of that's why the big, bigger because the big are generally the firms that those late stage, those quasi-public companies want to work with. I want to underscore your point about companies growing faster than ever before. And look, opening AI scaled from essentially nothing to, what is it this year, 3.7 billion

run rate or, you know, maybe it's trailing revenues, whatever, huge number. But it's also showing up in other companies. I'm cursor, which just, I think they're closing around at 2.9, 2.5 somewhere in there. And I was reading that they grew from $4 million in annual revenue to $4 million in monthly revenue in an incredibly quick timeline. That's a pace of growth. That's simply insane. Yeah, it's crazy. Honestly, I think I think cursor at two and a half is undervalue, but that's a different story.

But that people are chasing those prizes. I just, that company probably won't go out until it's worth $20 or $30 billion. That means it's going to be another eight, 10 years. I mean, it's just, it's just, it's. Yeah. You see a lot of value accruing in the private markets. I think the interesting thing with AI in particular is like there's just going to be a lot of headfix. There are going to be a lot of companies that grow really quickly and the growth curves kind of look like this and then they stall, maybe go negative.

And some of them will either rebound back up or go negative and just kind of fade to irrelevance. And because what happens is you go to any big company. Everyone's boss says to them, hey, Alex, like, I want you to introduce efficiencies to our business with AI. It's a mandate. You say, I got to go do that. You're just going to go out and buy a lot of AI solutions because it's your mandate. And you might not have a clear-cut ROI case to be made, but there is a demand for AI efficiencies in our business.

I think you see a lot of companies growing really quickly off the back of that, right? You're not doing a full RFP. You're not really saying, let me evaluate three solutions. I need to buy it and I need to buy it now. I do think what's going to happen with a lot of the AI startups is there are going to be some that kind of are on that trajectory, that are best of breed, that are end of one, that then continue once we get a little bit more scrutiny on AI procurement and AI purchasing. But there will certainly be a lot that grow really quickly, that become commoditized, that

grow really quickly that are actually the number two or three in their space, and then they really slow down and they see a lot of churn. You know, we had Eric Vichry at our Investor Day not too long ago, and like he said this very well, which was, you know, like, we expect a lot of the companies that we invest in to slow down or decline at some point in the next one to two years. That isn't what we said about kind of classic SaaS and classic software. It's what we expect to happen in the AI world. I don't want to misquote him. So if I said it wrong, he can correct this after the fact. It's close enough, I'm sure. Yeah. But there's, you know, like, why we're investing in the companies

that we're investing in the companies that we're investing in the inevitable slowdown that will happen. Like, we're investing in best of breed companies that will then continue to grow once kind of the dust has settled in a lot of these AI categories. I appreciate you talking me through this. Watching venture capital from the outside is incredibly interesting and fun, but it's always good to get kind of a horse's mouth perspective on things. So thank you. And I'm just going to say it again,

clouded judgment.substack.com. I am a huge fan. I've been reading it for a long time, and it's more popular than my blog. So you jammin. Okay. So now on to our favorite stuff, which is SaaS multiples and kind of what's going on in the world of software economics.

Over on Clouded Judgment, you had a chart showing quarterly performance versus consensus estimates for the last earnings cycle. And if you're watching the video, you'll see on the far right, we have 100% of companies that had reported when Jammin put this chart together, in fact, had beaten consensus estimates. So to me, Jammin, that would imply that the SaaS market is incredibly healthy right now, and yet market enthusiasm for SaaS, as we discussed earlier in a multiples perspective, is relatively limited. So is this just clearing a low bar? or is the public market being a little bit parsimonious with its multiples?

Yeah, you know, we'll see. I'd say it's always hard to draw a trend from one data point. But, you know, like historically, and when I say historically, I'd say like the markets for SaaS got puff in, you know, 22 and 23, right? The SaaS occur, the SaaS apocalypse, whatever you want to call. Like selling software got hard as we came out of this ZERP period. People focused on cloud optimization. They focused on reducing redundant spend, right?

There's just a lot of contraction and emphasis and focus on driving efficiencies, particularly around how you buy software. We've kind of been in this period for two years, right? So prior to that period, and even prior to ZERP, you know, like, you'd see kind of 95 to 100% of companies beat quarterly consensus estimates. You know, why is that? It's because there's a beat and raised model in software, right? Like, slightly beat, you know, hitting the estimates is actually a miss, right?

Because you've built in a margin of safety and you basically missed that margin. And people know you've built in a margin of safety, to be clear. Exactly. They know you're sandbagging just a little bit. It's sandbagging, exactly. You know, again, so in this period, that was harder, the 22, 23 period, you know, that dropped down to 90%. You know, now all of a sudden, 10% of companies were missing the quarter's consensus estimates. And I don't remember exactly off the top of my head, but, you know, and then companies report a quarter, but then they also guide.

You know, we dropped from something like 70% of, or 80% of companies, then guiding above consensus for the next quarter to 50% of companies guiding ahead for next quarter. consensus. And so I'd say, you know, that chart, it's not 100 percent, you know, there have been some companies, software companies that have missed earnings. This is just like a lot, the longitudinal same basket of companies, you know, over a period of time just so kind of it's more of an apples to apples comparison. But of the, I think there's about 30 companies so far that have reported Q3, like all of them have beat. And they've kind of in the margin with which they've beat has gone up relative to the last couple quarters. And so, you know, that's maybe more indicative of, hey, is the buying behavior changing? You know, we might also be

getting towards the year end and look like there's just a lot of positive reflexivity in the market today rates are going down. You know, Trump's elected. People say, are the tax cuts going to be permanent? Is that going to be stimulatory? Is Lena Con out? Is M&A? You know, like, there's just a lot of, you know, if you're more cautious about buying budgets, I'd say everything that's happened over the last six months makes you less cautious. Yeah. And so you're more likely to kind of spend that budget for 24 that you haven't. That's sitting on the shelf. And so it could just be like a budget flush. That's what that's called that we're kind of heading in. into towards the year end. So again, I'm hesitant to necessarily say performance is starting to

rebound because if we rewind the clock back to Q4 of 23, which those companies reported those quarters in January and February of this year, software performance really ticked up. And people are like, we're back. It turned out that was kind of largely just this budget flush, well, it's just my theory, but other people as well, it was just budget flush the end of 23. People had an unuge budget that they kind of spend at the end of the year. And the environment hadn't actually really changed. It was just this kind of one-time thing. chart from Cloud of Judgment that shows the aggregate cloud software, net new ARR Y-O-Y growth chart, and it went up as 23 ended, and then it went balk, and then it went up again.

Yeah, and so we'll, you know, we'll see if one data point is a trend or not. And, you know, again, you're not going to know until it's obvious in hindsight, and the market will move ahead of, of that. And so I think multiple software multiples have, I think the median has kind of hugged right around six times over the last few years and, you know, historically pre-COVID, the median was around eight times. That comparison, just for reference, like the eight times median software multiple from, I don't know, 2010 to 2020 occurred when the average 10 year was about 2.2, 2.3%. So eight times and 2.2%. Today, we're at six times and 4.2%. So rates are still higher. And ironically, as the Fed have cut rates, the tenure has actually gone up. I know.

from kind of 3.8, 3.9 to 4.2. But I think that's just as views of the strength of the economy have continued, right? And then maybe views of, hey, will inflation pick back up? And so if you have a strong economy, you don't need to cut, if some of these tax cuts with this new president are made permanent, is that, you know, I think you just have, there's lots of reasons for why rates have gone up. But yeah, we're at six times today. And so everyone looks at the historical average and say, oh, eight times, like,

that should be a 33% multiple expansion. But it's like, hey, let's remember that also was when rates were low twos. right now rates are low fours and so you know rates will have to change for for kind of multiples to expand or companies will need to. But even if we got to a 2% rate again, even if we got to 8x, yeah, that doesn't solve a lot of the problems we discussed earlier for unicorns and stock companies. That probably provides a more attractive IPO window. It probably makes some M&A a little bit easier to do. But that's going to like cut your fever from 103 to 101 degrees. It's not going to get you down to 98.6. That's right. That's right. That's right.

That's tough. Okay, so one last question. I recently talked to the CEO of Amplitude, a public company at 2021 IPO, Love Spencer. And I was reading through the earnings reports. And one thing that kind of caught my eye was he was talking about how the era of software, you know, people trying to cut back on their spend and dealing with overpurchasing was kind of coming to an end. And that, to me, just felt very, very bullish for startups next year. And so I just wanted to put that to you and say, hey, do your portfolio companies in the

boards that you sit on seem to be pretty optimistic about next year? I'm trying to get a vibe for January, Janet. Sure. I think we're seeing some signs of that. And I'd say you look at the hyperscalers and what are they saying, hey, this focus on cloud optimization has eased and the focus on new workload growth has grown. And so I think you're hearing a lot of consistent messages from the folks who are giving us big public statements. I think the thing to be wary of is in 21, in the ZERP period, like everyone benefited proportionally, right? Like every company, whether you were the best of breed, whether you were the third in your category, like you all benefited.

And so it's important to call out that as the software buying environment thaws, we're not going back to this like it's easy for everyone. What we're going back to is it's going to be easy for the best of breed, the leaders in categories with differentiated products who, you know, have a right to win that incremental budget. And so I think there is a little bit of like a disqualification. illusionment that, hey, we're going to get this snap back when rates go down and it's going to be easy for everyone. But all of the muscle memory that's been built into every procurement team,

everyone buying software over the last two years, your CFO like cracking the whip behind you about you can't buy this product because we're already spending for something else in this org that's similar, like no redundant spend, sorry, you don't get this, standardize on that. Like, that muscle memory around procurement of stuff, like, that's not going away. Okay. Right? And so like that, because it has been like whipped into people. And so budgets might get bigger, but there's still going to be a lot of scrutiny on them. There's still going to be a lot of like, why this versus that. What's the ROI? What's the business case? What problem does it solve? How much revenue is going to generate us? How much cost are it going to cut out? Jammin, this was my attempt at Indian on a positive note. And I feel like you just brought in the procurement department and CFO's cracking whips. You're supposed to be throwing some joy out here, man. Yeah. Yeah. It's really Christmas. No, look, I think, yeah, it is. I think it, look, it is what it always has been. Right. Companies that are differentiated, playing in big markets, are going to big build businesses. And those who aren't are going to struggle.

And I think it's important just to call it out because we did have this period of disillusionment where it's like, hey, everyone's going to win. And the reality is, is everything over the last few years has kind of been a theme of just like reversion to the mean. And like everything we're witnessing now is just exactly that, a reversion to the mean. The reversion of the mean where it's not reverting is the wall of capital looking to get into venture. And that's going to remain distortive to your point about incentives. But if you want to know which companies out there are the breakout winners, I would

recommend Airbyte, Clickhouse, DBT Labs, LiveKit, and Prisma, which are the boards that Jammin is currently on. So if you want to know where he's placed his bets, there you have it. Jammin, a real treat. I'm going to have you back on in like six months to talk about what goes on in the new year, the new administration, startups, exits and IPOs. But I'm really hoping that you and I get as many IPOs next year to chew on and look at as we are hoping. Because my gosh, we have been starving these last two years. You and me both. All right, dude. Thanks for coming on. Jammin Ball. Jammin Ball on Twitter, Cloud of Judgment over on Substack. He's the man. We'll have him back. Bye, everybody. See ya.