This Week in Startups - Tomasz Tunguz and David Clark on how to invest in AI and Q1 2024 startup valuations | E1930

Starting point is 00:00:00 I was watching Gary Vaynerchuk, Gary Vee, and he said every now and then he opens up his email from Brian Chesky at Airbnb and just stares at the fact that he didn't even reply. And he just stares at it. And when I introduced 21 people to Uber, I remember Mark Suster was in the room and he couldn't get there. And he missed the investment. And to this day, Mark and I earn a couple deals together. He just shakes his head sometimes. Oh, man, how did I miss it? This is a $4.5 million round of Uber he missed.

Starting point is 00:00:31 This week in startups is brought to you by Squarespace. Turn your idea into a new website. Go to squarespace.com slash twist for a free trial. When you're ready to launch, use offer code twist to save 10% off your first purchase of a website or domain. Open phone. Create business phone numbers for you and your team that work through an app, on your smartphone or desktop. Twist listeners can get an extra 20% off any plan for your first six months at openphone.com slash twist. And CLA, innovation takes balance. CLA's, CPAs, consultants,

Starting point is 00:01:16 and wealth advisors can help you get from startup to where you want to end up. Get started now at at clyac connect.com slash tech. Welcome back to this week's liquidity podcast. With me today, I have David Clark from Vencap. Next, we have Tamash Tongis from Theory Ventures. And of course, JCal, from the launch fund. I'm your moderator, David Weisperd, co-founder of 10X Capital. Today, we have two great topics on the docket.

Starting point is 00:01:43 There's a new YC class, and the data is out on the new class, and there's already several breakouts. And we discuss startup valuations for Q1, 2024, which are fresh off the press. We'll end with the latest three investments from each of our guests. Let's dive right in. Y.C. had its demo day last week and the VC community is a buzz. Under Gary Tan's leadership, the winter class showed a significantly smaller batch size and acceptance rate of less than 1% from 27,000 applicants.

Starting point is 00:02:12 Several VCs have expressed excitement about the new class, especially around several AI companies, which seem to have dominated the headlines. One company, Leah, an AI assistant for lawyers, has already raised a series A from Benchmark. Gary Tan and a text to blogger Eric Newcomer highlighted practical AI as a major theme playing out in the current bats. Tomash, what are the opportunities today in AI?

Starting point is 00:02:40 How do you think about the differences between co-pilants, assistance, and agents acting on behalf of users? Yeah, so we see two different kinds of opportunities in AI. The first one were co-pilots. Those are the systems that ought to complete sentences. What we've seen with those is 50 to 75% improvements in productivity, Microsoft and Service Now, both reported that.

Starting point is 00:03:03 They work pretty well in the legal context, too. And then the second category we see are agents, which are robots or computer programs acting almost entirely on behalf of users. And their full sale development rep replacements is one, security operations analysis is another, Klarna cut, two-thirds of their customer support team with agents. And so for any jobs that are broke or require processing lots of data and customizing the output, they're really good. If the productivity gains or anything close to mechanical relevance, we would expect that these AI agents actually replace something like two and a half workers on average. You saw Gary Tan talk about practical AI.

Starting point is 00:03:41 Is it too early for practical AI? Should investors be thinking much bigger than the verticalization of AI? No, I think that's the right place to start. The main reason is, I mean, we talk about AI. Startups had negative time to launch. What do we mean by that? Really, the big companies have got a big jump on it, Microsoft and Google and others, because they had the vast majority of PhDs, they had all the data.

Starting point is 00:04:04 And the key unlock within this LLM wave, it's just scale. So the response that by startups to pursue vertical AI makes a lot of sense. You can't compete with Microsoft and Word or PowerPoint or any of their core markets. You have to compete in areas where they're not paying attention or the data sets are unique. So it makes a lot of sense that we would see it vertically. Another account example would be like RPA, right, UiPath, $10 billion company doing robotic process automation. It's fairly straightforward to deploy a basic version of a large language model or AI-enabled robot. And so you can't compete or it's very challenging to compete with a direct assault on some of these big companies.

Starting point is 00:04:44 You have to go and pick a workflow. You have to go and pick a dataset that those companies don't have. Jason, you've funded quite a few AI startups. What are you seeing in terms of your early breakouts? Yeah, just on Gary Chan's comment, I like the comment that practical AI, I guess that's like saying useful AI, or you can use this AI. It's practical to use it. I think that's a bit of a reaction to the last class, which was considered rappers.

Starting point is 00:05:14 And like, oh, is everything going to be done natively in Claude or chat GPT for, or Gemini slash Bard, Microsoft's co-pilot. So that is still an important discussion, I think, to have, which is verticalized AI versus generalized AI. And practical, I think, is a way of saying verticalize. And Rapper is a derogatory way of sort of dismissing what would be transient startups that don't make it. Now, of course, 80%, 90% of startups in the incubator space,

Starting point is 00:05:50 base go to zero. You have to let the founders figure this out. And that's the phase we're still in. It's pretty obvious who's going to win the hardware stack. It's not going to be a startup, right? Invidia, Intel, AMD, risk. I mean, there's just so many players there. It's so capital intensive. I don't see some startups, you know, breaking in, in all likelihood and taking that market share. It's possible. I just, I would say possible and probable are how I tend to think of the world. And that feels improbable. Then you get to large language models. I think we're already starting to see those come apart with Mustafa going to Microsoft and, you know, some of these large language models getting overtaken and open source models doing really well. So, you know,

Starting point is 00:06:36 there's, there's kind of, I think, it would be some problems there with a lot of these becoming commoditized and indistinguishable. I'm sure, Thomas, you're seeing this in some of your companies where they just switch. They're on Claude. They're on chat, GP4. They take the same prompts. They move around,

Starting point is 00:06:52 which makes me think that some of these language models might actually be not worth what they're worth. And that, you know, meta and Apple and the open source community releasing these things is going to be right where the startups go.

Starting point is 00:07:06 Remember, startups are super efficient by necessity. Like, you know, they're already behind the curve and trying to catch up here. And they're also resource constraints. So they're going to go for the cheapest solution,

Starting point is 00:07:17 and the cheapest solution might turn out to be open source. We'll see. But that means just massive pressure pushing down what people can charge for their API. So then what does that leave? That leaves verticalized applications.

Starting point is 00:07:28 And I think that's where AI is but one component of it. You know, multiplayer mode. When you're using, pick any verticalized tool, Zendesk, grammarily, etc., you know, multiplayer mode, your history, the features, Squarespace, constantly releasing new features. It kind of makes these things super sticky.

Starting point is 00:07:49 And so I think that's what's happening here. We're starting to see startups get traction and people really enjoying their products. So I'd say this is like the sampling era. Enterprises are sampling these products. And the really hard part is going to be, are they accurate and useful enough? Not are they like intriguing?

Starting point is 00:08:10 Intriging is easy to cancel. And I think we're kind of like, this is where founders have to work really hard, from intriguing to essential. You know, some things can be intriguing. And you try them, you put in your credit card. I put Oculus, like, you know, VR into this. I say, it's like, try, oh, my, goodbye. People try every holiday season, these Oculus, the latest version. They're like, oh, my God, this is incredible.

Starting point is 00:08:38 And then it goes in a drug. Nobody ever sees it again. And I really have this fear about AI right. now that there's a lot of sampling. It's intriguing, but are people actually using it? I think we're going into the, what do they call that? The trial of disillusionment and then we'll actually come back. So it's going to be a very interesting couple of years. One percent is, you know, what YC always kind of accepts. That's kind of what we accept to just under one percent. How many people were in the class? Does anybody know the exact number?

Starting point is 00:09:09 260. That's pretty big. Yeah. That's still pretty big. So they're still doing 500 a year. Yeah, shout out to Dave McClure 500 startup. So I'm starting to see a lot of sampling and we'll see if people can make these tools so good that enterprises renew for years two and three and they expand it beyond pilot. So it's pilot season. We'll see who becomes, gets picked up. One thing that drives me crazy is when I want to buy something on a website, but there's too much friction when I go to checkout, right? I want to make the impulse purchase. I'll be totally honest. I see something I like. I got these new reader glasses. You know what? It was so easy because there was no friction. That's what I want. I want to be able to have a smooth and easy payment experience, but it's got to be safe and secure, right? I don't want people hacking my credit card. And I like to have many different ways to pay. I want to use my digital wallet, obviously. And then, you know, other people might be in the buy now, pay later period of their life. No judgment's there. If you want to be on a payment plan, that might be a good idea for you. If you're a merchant, you got to be able to offer alternative payment methods, APMs. This is critical. And you know who's the best of this? That's right. Our friends at Squarespace. SquareSpace,

Starting point is 00:10:13 payments makes it easy for customers to make purchases, which equates to more revenue for your business. Super easy to set up, and it's going to keep your revenue growth going up and to the right. So check out Squarespace.com slash twist for a free trial. Squarespace.com slash TWIST. You get a free trial. When you're ready to launch, you just go to Squarespace.com slash twist, and you get 10% off your first website or domain purchase. Squarespace has the best design. They constantly release great features like Squarespace payments. They study their customers, you and I. And they ask you, hey, how can we make a this better. And when they make it better, they give it to you and it's for the same price.

Starting point is 00:10:46 That's what I love about Squarespace. Every day, I wake up with new features in that same affordable price. Squarespace.com slash twist for a free trial. Tomas, when you're going after a market like AI that's changing so much, are you still focused on backing the best founders? Are you more focused on the application and the market? I think it all comes down to the team. I mean, what Jason said resonates with me, which is this market changes so fast. It reminds me of the crypto market two years ago where you go to sleep and you wake up and there'd be two or three new research papers on how to do something in a better way. So whether it's a new machine learning model or a new technique for analyzing the data

Starting point is 00:11:24 and the performance characteristics are significantly better. And so what we're looking for are founders who understand what the current state of the art is and are planning for that state of the art to change rapidly because the cost structure will change. If you look at the current GPT4 model and you pick the fastest and the fanciest one, it costs about $60 million for about a million tokens. And if you take the version just before, it's 120 times less expensive. And so there's pretty huge difference in pricing power from those models.

Starting point is 00:11:58 Tell you they commoditize super fast. In this ecosystem, I think the companies that will win with AI, they have two attributes. The first is they're the companies who can respond to technology. change this really fast and don't have a dogmatic view on how to solve the problem, all of a sudden, the transformer, which is a key innovation in the current wave of AI, is no longer really the right thing, to be willing to abandon it for the next version of AI, whether it's multimodal or any of these other techniques.

Starting point is 00:12:26 The thing that really matters and what I think will sustain is distribution. That's what we realized in the software wave was acquiring a customer is actually more expensive of each year. Over the last five years, there's been a 60% increase in the cost to acquire our customer across software companies broadly. And so the founders that we really get excited about are the ones who look at the technology and say, I can build a product. And as a result of building that product in a very particular way, I have a customer acquisition advantage. And so I can acquire those customers less than my competition can. Ergo, I can grow much faster groundless capital. And so that combination of finding a technology advantage that is produced as a go-to-market

Starting point is 00:13:12 benefit is that that's what we're really after. Dave, as a fund of fun, you have a lot of your GPs going after the AI companies in this new wave. Are you happy? Does it make you concern that so many of your managers are going all in on this trend? I think it's really interesting And it's just interesting to listen to the discussion between Jason and Tamash as well, which I think one of the things I'm hearing there is that we're still so early in this shift that it's almost impossible to get a sense of where the value is actually going to accrue, who the long-term winners are going to be. And to some extent, it reminds me a lot of the dot-com boom back in the late 90s,

Starting point is 00:13:54 where there was a lot of excitement early on. There was some really interesting experiments that were, that were, underway. But ultimately, you know, very few of those companies that emerged during that time went on to build sustainable businesses. And I know, you know, Jason Statt about, you know, 80 to 90 percent of these companies ultimately aren't probably going to make it is something that, you know, we wouldn't be surprised to see. But I think the flip side is that, you know, just as we saw a handful of companies emerge out of the dot com era to build, you know, really significant businesses, I think the expectation that we would have is we'd see something similar

Starting point is 00:14:29 from this paradigm shift on the technology stage. So our expectation is that there are going to be some huge franchises that are built out of the AI space and you have to make your bets. And so, you know, we would be very disappointed if we weren't seeing our managers being very active in this space. What I think you will see is over time, it will be the best managers who can really differentiate themselves. And I think, you know, just as we saw during the dot-com period, we saw during the mobile

Starting point is 00:14:57 period as well and, you know, perhaps with crypto, I'm sure there'll be a new breed of managers that emerge that are, you know, AI native that really start to emerge from that pact. So from our perspective, I think it's always really interesting, you know, during these sorts of times because you will see huge amounts of disruption at the company level, but also at the venture firm level as well. And I just hope that, you know, the bets that we've made with our existing managers, you know, ultimately prove out they've been able to navigate, you know, a number of these technology shifts before. And just looking at some of the early bets they've made in this space,

Starting point is 00:15:31 you know, we're hopeful they'll be able to do that again. Yeah, that resonates with me a lot, which is, you know, it's kind of our jobs as GPs to figure out where the opportunity is and to pick the best teams to pursue those opportunities. But at the end of the day, the founders are on the front line. Their talk, you know, it's kind of like if you think of like a war, you know, there's people on the front. And when you're on the front and you're seeing what's happening, hand-to-hand, combat, how people are using it. They have really good information there. They're going to be

Starting point is 00:16:00 able to pivot and find the opportunities. And, you know, we're kind of like generals moving back. And then there's like the LP class, which is enabling the generals to then enable the troops. And there's some metaphor here that works, but we're abstracted a little bit, you know, and distance from the work. And there's advantages to be distance, right? You know, Dave can look at Thomas, myself, and others and kind of think about how we're thinking about. about how the front line is, you know, engaging in this war to see who's going to win it. And it's very early. We're very early in this.

Starting point is 00:16:35 And, you know, we look for great teams that are technical, that have multiple co-founders, that have product velocity, and that really understand their customers and are talking to their customers constantly. And what I found in my career is the people who are very close to the customer base, who have product velocity, who are aggressive, and have, you know, really good building and are close to the customers, they find the opportunity right quick, right? This may take them a couple of pivots. They could be major pivots.

Starting point is 00:17:03 They can be minor pivots. And that's the mode we're in right now. It's going to be a lot of zeros. And that really is the name of the game. If you think about Y Combinator launch, Founding University, tech stars, any of these programs that are really early, you know, what we're doing is experiments. And then I think, Tomas, you're writing these 500K to $2 million checks. the seat stage mostly now.

Starting point is 00:17:28 A little bit later, specifically like two to three to about 20. Oh, okay. So yeah, you've moved on, you've moved down the funnel. So you're putting in two or three million. You're looking for teams that have a product and market and some customers already. And then where we sit in that pre-seed, you know,

Starting point is 00:17:45 we're looking for teams with velocity and one customer, you know, maybe two. And, you know, they're figuring it out. Tomas, looking for when you make your decision? Because we're really betting experiments. You're betting on a little bit more proof, yeah? Yeah, we are. We run a really concentrated portfolio.

Starting point is 00:18:06 And so the way that we work is we'll research a space for six or nine or 12 months. And we have about 100, we call them theorists who help us understand those markets and who are buyers. So they can be heads of data, like major software companies or inside of big banks. And we just talk to them and try to understand, like, I mean, one of the major problems in selling AI software to every major enterprise right now is security. Everybody's afraid that I'll give you an example. A friend of mine runs a company.

Starting point is 00:18:35 One of his engineers deployed large language model inside of the company, opened up a chat bot. One of the employees asked, what is David's Social Security number? And David's Social Security number came out. And so there are all these kinds of new questions, right? Like there's another question which is, okay, there are these agents that are acting on behalf of people. how do we onboard them into a company? Do we onboard them through like classic HR processes, permission them and give them permissions like that?

Starting point is 00:19:00 Do we give them performance evaluations like a human? And then we off-ward them when they're not performing. And it's a little bit tongue-in-cheek, but I think there are lots of questions that we're looking to answer. And once we have that information, then we try to exactly put Jason's that we're looking for really strong teams. They might have a handful of different users. we try to introduce some of those startups to some of those buyers,

Starting point is 00:19:25 see whether or not we can help them close in business. And if there's good signal product market fit, then our goal is to invest. Moving on, Carter just released very fresh data from its Q1, 2024 startup valuations. Round sizes at the seed and late stage are significantly up with the late stage experiencing an increase in valuation. Tomash, if exit valuations continue to be depressed due to the IPO market being close and regulatory issues around large MNA, what does that mean for venture? Yeah, this is a big question. So we had this era the last 10 years, zero interest state environment where you have forward multiples, which is the way that we value publicly traded

Starting point is 00:20:05 software companies go from about 5x to about 15x during that period. And venture was amazing. It grew from an $8 billion asset class to about a $300 billion asset class at the best exit market ever in venture. And now we've got to a place where Rates are at 5, 5.5%. Larry Summer said today that he thinks the Fed will actually increase rates. And so that sort of depresses exit valuations. Now the question is, okay, well, the exit valuations are depressed, but the entry prices are going up, basically at the rate of inflation, 3-4%, will returns be squeezed. And, you know, I mean, the reality is when we make an investment, on average, it takes about 7 to 8 years for it to be sold if it will be an M&A and it'll take about 12

Starting point is 00:20:49 years to go public. So the current valuation environment is not necessarily representative of where it is. On the other hand, you do have a lot of regulatory pressure. So if we look at what the antitrust against Google and Facebook or Microsoft and Apple, if you look at the top five or six companies who are historically been the big acquires and you look at the AI entry valuations and assume that those companies are out of the market, right, like even the strategic investments that some of Amazon is making into some of these LLM companies or Microsoft is making an open AI are now suddenly subject to regulatory scrutiny. If you take those five or six companies and assume that they're out of the MNA market,

Starting point is 00:21:29 that's about 70% of dollars and 75% of market gap. And so your largest, your trillion dollar scale acquires are basically out of the MNA game until there's a change in the regulatory regime, Washington. So that's probably a short-term issue rather than a long-term issue. But I think it is an important consideration when you're looking at entry valuations. And what we've seen, particularly for the hottest AI companies, is they're being priced the way that they were, the company startups were being priced in 2021 at the height of the zero interest rate environment where a company at $2 million in ARR is being traded at $2 to $400 million.

Starting point is 00:22:07 We saw one AI company, 250K and ARR, raising $50 million at north of $250 million valuation. And the idea of the excitement from the investor side, there's some rationality, which is, this is a power law business, one or two of these companies in a portfolio can make a portfolio super perform it. But you really have to pick your spots because the entry prices are big, which means the check sizes are big. So if they don't perform, the loss to the venture permit can be significant. Yeah, and I just thought I'd bring up as a proof point to what Tomas is saying is, you look at this Reuters story here about the Microsoft. deal to buy inflection. They didn't buy it. But they did some sort of $650 million licensing deal, took the top talent. This kind of feels like an acquisition to me. They gutted the fish. They took like the prime parts of it. They took the tuna belly. What's left?

Starting point is 00:23:01 There's some carcass that was thrown back in the ocean. And this feels to me like, you know, what capitalism does when you try to constrain it. You try to constrain something like capitalism in a democracy like America. People get real creative. And, you know, Microsoft, pretty creative organization, and they just stole this company. I don't know how this works on a tax basis. I don't know what this does to the venture farms that invested in this company and the LPs who backed those VCs to do this. But, you know, they took Mustafa and they took, you know, Karen and all these people away from inflection. They left some carcass.

Starting point is 00:23:42 and, you know, but inflection AI had raised like a billion dollars. So what is happening in this? And I think this when, you know, it seems like Trump has a, you know, whatever, 55, 45, 60, 40 chance of, you know, of, you know, winning this election. And then Lena Kahn's going to be out. And then what does M&A look like in this next cycle if, you know, and listen, I'm no fan of Trump. I've said it here before. where people know my feelings on him. But I do think getting back to a more healthy M&A environment

Starting point is 00:24:16 would be better for our industry and for innovation writ large. And so we've got to figure something out because these kind of weird deals going on or remember Microsoft just saying, oh, we'll just take the whole open AI team. They'll all just come over. Like, this is a direct result. And then there was Apple with the watch team. They just raided that company, didn't give any money to them,

Starting point is 00:24:39 gotten a big patent dispute. So weird stuff is happening when you try to put your thumb on the scale of capitalism. And so we got to figure this out. Entry price does matter to the card of data we're talking about here. Entry price matters. And when Tomas and I were starting, seed deals were five, series A's were 12 to 20. Now seed is 12. Series A's are 30, 40.

Starting point is 00:25:04 And so, you know, it's arguably 3x. and I don't know that the exits are going to, maybe the exits are bigger. You know, if the exits are big enough, fine, but, you know, there's very few decacorns, you know, that ever get created. And I think the way the portfolio architecture work, and Dave, you would know more about this than us

Starting point is 00:25:26 because you've done homeless data, but what is the $300 million dollar firm need to do in order to have one of their companies pay for the fund or double the funding and get you at least to a two and a half X for the fund. How do you think about that portfolio mass given the exit strategies? Yeah, it's an interesting one. And I think, you know, for us, it's a real challenge because I think when we look at what firms are doing on an individual basis, it kind of makes sense because, you know,

Starting point is 00:25:57 particularly for early stage firms, the bigger mission you can make is not going after that top one percent company because the valuation is a little bit too rich. You know, we've seen it time and time again where if you get the selection right, in a way, the valuation is much less important at the early stage. And so I think, you know, as an individual firm, those firms are acting logically and rationally. It's when you combine all of that activity that it starts to look a little bit crazy because you know that there's only a limited number of those top 1% firms by definition that are going to generate the value that they need to do in order to justify the price

Starting point is 00:26:35 and to generate those sort of returns. Specifically to your comment, though, Jason, you know, if you're looking at a sort of four to five hundred million dollar early stage fund, you know, if you own 10% of a business, you know, that needs to be a five billion dollar business for that company to return your funds. If entry prices, rather, are starting to rise significantly, then either you're going to have to write much bigger checks. So you've got less shots on goal from that $500 million fund,

Starting point is 00:27:04 or you're going to have to reduce your ownership. And if you reduce your ownership, that means that your exit size is going to have to increase in order for you to get that to the fund return a level, to return that $500 million. So I think, you know, we've seen in the past, you know, several things like that happen. There've been a couple of funds that we've invested in that have kind of gone from having, you know, 30 early stage deals to just over 20. And they did that because they wanted to maintain their ownerships, but they didn't want to increase their fund size.

Starting point is 00:27:35 So there you're putting real pressure on your ability to select that one company that can go on to be that fund returner. And you could argue that if you're doing a third less deals, that's giving you a third less chance of finding that one company that could go on and really drive your performance. So I remember Chris Duvoss, I think it was, who said that venture works best when capital is scarce and time is plentiful. And I would definitely buy into that. It is something that does give us pause for concern. The challenge is, what can you do about it? Because you know there's going to be some of those key companies that will emerge over this period.

Starting point is 00:28:16 So you don't want to step out of the market and fail to participate. I think the best thing we've seen is for firms to remain reasonably disciplined, to make sure that they're still operating over a three-year investment period and not get carried away with all the fear of missing out in the excitement that they put funds to work in in 18 months. And it may be that forces them to raise the bar in terms of what they're willing to do in order to get to that three-year investment period. That's, I think that's the key thing that we would say, you know, when we're talking to VCs in this sort of area, it's keep that time diversification in your portfolio.

Starting point is 00:28:51 Because, you know, as we saw with the deals that were done in 2021, it doesn't take very long for that environment to change in those deals and those prices to look very different. Juggling multiple devices and apps to run your business is a mess. Open phone is here to make it simple. By simplifying your business communications with one easy-to-use app. Open Phone has rethought every detail of what a modern business phone should be. And here's the magic. It works through a beautiful, elegant app on your phone or you can just use it on your desktop,

Starting point is 00:29:23 making it super easy to get a business phone number for your entire team. And you know how brilliant open phone is? My teams use it every single day. My sales team loves it. My ops team, they use it all day long. And here's the features that we love. You can create a shared phone number like customer support with multiple employees fielding all the calls and all the text to that one number. At my investment firm launch, we pride ourselves on replying to every single call or email instantly.

Starting point is 00:29:49 And open phone is the number one rated business phone on G2 for customer satisfaction. So here's your call to action. Super easy. Open phone is already affordable. starts at just 13 bucks a month, but Twist listeners get an extra 20% off any plan for the first six months at openphone.com slash twist.

Starting point is 00:30:05 And if you have existing numbers with other services, no problem. Open phone's going to pour them over easy, peasy, lemon squeezy, no extra cost. Head over to openphone.com slash twist to start your free trial and get 20% off. So what you're saying is a fund should take the full 36 months

Starting point is 00:30:22 to do that primary deployment, not shorten it to 18 to 24 months. and you got to take your time. And yeah, that's a little scary to think that some folks went from 30 to 20, a third less shots on goal while prices are going up because they want to maintain their ownership. But man, it's really hard to find an outlier. And they still need to, if you're a $500 million fund, you still need to find a deco-corn. Decacorns are hard to find.

Starting point is 00:30:52 It's like Robin Hood or better, right? We're not even in the, you know, Uber $100 billion. Exits are hard. Valuations seem to be plentiful. It's kind of, you know, I don't know. Tomas, how do you think about it? How many shots on goal you can have in this fund? And what fund are you on?

Starting point is 00:31:10 We're on fund one. We'll probably have 15 shots on goal. So we have a very concentrated portfolio. Wow. And we're really focused on ownership. So I think we're there, we ran a bunch of simulations. on historical venture data. They come up with our portfolio construction.

Starting point is 00:31:29 But you said 15? 15. 1.5. That might be the lowest I've ever heard. When I wrote my book on angel investing, I asked, you know, everybody I could find how many angel investment you think you need? And that's early stage, seed stage.

Starting point is 00:31:43 Do you think you need to hit an outlier? And the most common answer was 30 or 40. So. Yeah. Yeah. So that's what we're running. I think that there's two dominant structures. strategies that kind of come out. One is the broad index with a later stage

Starting point is 00:31:58 concentration vehicle. I think that's one model that comes out of the analysis and the other is a highly concentrated fund where you have significant ownership of the companies. You model what you think the exit valuation will be primarily for M&A. It's hard to bet on IPO. The IPO market's been closed for last years. What did you do before the fund? Were you doing just

Starting point is 00:32:17 syndicates or seed deals? No, I was at Red Point for about almost 15 years. Got it. And the management director there for a buddy. Yeah. That's a bunch of companies. When did you raise this fund? I raised it.

Starting point is 00:32:30 We closed in March of 23. Oh, wow. It's a hard time to close, huh? It was a tough fundraising environment. I remember this was when all of a sudden the stock market was tanking and rates were going up quite a lot, that most of the LP population was simply just trying to understand, like, how much of my book is in public markets, how much of my book is in private markets, and the public markets.

Starting point is 00:32:54 obviously correct at the time, but the private valuations hadn't been written down yet. So everybody thought that they were massively over-allocated. How big was the fund and how many meetings did you have to do? We raised about $238 million and we had a lot of meetings. Hundreds. That sounds like a 200 meeting. How many 12 months, 18 months on the road? A little less. We were able to raise just under like four or four and a half months. How was it during the Silicon Valley Bank implosion?

Starting point is 00:33:25 Were you caught up in that? Yeah, a good memory. So the day we were supposed to have our first capital close was the day that is being imploded. And so all of, as you can imagine, all the LPs in the fund called and said, we're not wiring because we have Silicon Valley Bank account. We don't know where our money is. We don't know if the website's not loading. Pretty scary. So then it took us, actually, it was really hard to get a bank account.

Starting point is 00:33:52 I know that sounds ridiculous, but we couldn't get a business bank account. The G-SIF, the global strategic investment banks, they wouldn't take us. Like, J.D. Morgan wouldn't take us. And Wells Fargo wouldn't take us because it turns out venture capital firms are terrible customers. We raise lots of money, but we don't actually maintain very large balances in our bank accounts. In and out. Capital calls in and out, yeah. Yeah.

Starting point is 00:34:18 And so the big banks that we needed to have a billion in a U.S. before they would consider taking us as a customer. Crazy. I called a friend of mine at one of the banks, and he was able to get us the banking up. But it was six weeks later. And anyway, it was, we were finally able to execute the capital call. But it was a wild time.

Starting point is 00:34:37 David Clark, you were talking before about how many funds were in market. You may have seen a stat. And it was kind of unbelievable to even think about. But you've been in this for 30, 20, 30 years, I think, as a GP. I mean, is, are we, how many venture firms are out there? How many are hitting you up and how sustainable is the number of firms right now? Yeah. So I just very quickly saw a stat that that was on a post on LinkedIn that I saw that

Starting point is 00:35:07 that was referencing data from Pre-Quint. And they said in January this year, I'm sure the number was six and a half thousand VC funds were looking to raise capital, which to me seems incredible. I didn't know there were six and a half thousand. VC funds, though I think I've probably had called emails from half of them since I was last on your podcast, Jayalston. Just so people know, I'm not in the

Starting point is 00:35:33 terrific 12 yet. I'm still trying to convince David. But you're very selective. I mean, it's just crazy how many funds there are and then how many aren't even making it to their second fund. The venture tourism is like a real thing. I mean, it's a real thing. That's the big challenge that we've seen. You know, we've had the misfortune of being in last, you know, the final funds that a manager has raised.

Starting point is 00:35:59 And it's never, it's never ended well. So I think, you know, if you were investor in that fund one and the manager is unlikely to raise a fund too, then that's a pretty precarious position for you to be in as an LP. You know, and I think one of the things that you really needs to get confidence in as an LP is, you know, is that manager going to be around for the duration? Is this what they're going to dedicate the next 20 years of their life to? Because, you know, Thomas said it's taking, you know, 10, 12 years for companies to go public. It takes 15 to 20 years for a venture fund to be fully realized. So this is a long-term business and you absolutely have to have that confidence that the firm's going to be around to manage that out. I'm just reading from Pitchbook here, Dave.

Starting point is 00:36:47 More than 247 first-time managers who close funds between 2019 and in 2021 will not be able to raise sophomore funds according to pitch book estimates. So there's going to be a lot of those funds. And it's got to be a bummer if you were an LP in those because you took all that time to build that relationship and then the person can't sustain it for the next fund. And I mean, I guess it's good for the survivors,

Starting point is 00:37:13 but it does feel like this is going to be a survivor's game. Yeah, no, I think so. I think that's absolutely right. There's definitely too many people. I mean, Tomas, can you pronounce your, how you pronounce Tomas so I can make sure I'm doing it right. With an S.H at the end. Yeah, thanks too. I knew I was doing it wrong and you, my dyslexia is going crazy.

Starting point is 00:37:32 Tomash with the S.H. I'm curious, you know, when you're co-investing, are you seeing, because you're doing so few companies and are you seeing a lot of co-investors kind of go dark or disappear on the cap tables? And how do you, have you had that happen? where board members are like, yeah, you know, we're out of business. And so did they stay on the boards? And I'm wondering what happens to those 250 funds that pitch books identified? Yeah, it's a good question. I mean, we definitely see some board members change.

Starting point is 00:38:06 A lot of the times that's senior partners who are deciding is their last fund and they're calling a career a career. I think, you know, in the case where a company raises fund one, or firm raises a fund one, has a board seat. and then isn't able to raise fund to go do something else. They still have a response. I mean, they would have a view here, but they still have a responsibility to see out that portfolio,

Starting point is 00:38:32 you always sell it and liquidate it. You know, the strip sales in like the secondary part of the market where venture investors are selling their stakes to somebody else is still a pretty small part. Everybody thought, I think, in the last 18 months, if there would be many more secondary sales than that have been. So, but if you raise a fund, you're committed to it. you sign a document, this is the limited partner agreement that says, I will continue to see out this fund as long as I

Starting point is 00:38:54 and all the positions as long as I'm capable. And so, yeah, I haven't seen a ton of it. But I think, I think you're, and I think the other dynamic there is a lot of those first time funds are probably they're not lead, they're typically not lead investors. And so they're not typically taking the board seat. And so there's just, there's less supervision that they might have to oversee the portfolio and understand what's going on within the companies. 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.

Starting point is 00:39:28 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. All right. Give us an overview of how CLA works with startups. What kinds of companies do you like to work with?

Starting point is 00:39:48 Is there like a specific zone where you like to engage with startups? One of the great things about CLA is that we're nimble enough to work with two startups, right? So whether that's a CED round or Series A company, but then on the flip side, we're large enough that we really have the depth of expertise that's needed to help companies when they become, you know, multinational entities with a lot of tax complexity or audited financial statements, consolidated corporations, you know, M&A, due diligence, whatever it is, right? So we can truly take them from incubator all the way to IPO and then really kind of come alongside some of the founders with our wealth management platform also like after the exit.

Starting point is 00:40:26 So I think CLA is really unique in that regard. Like there's not a lot of firms out in the U.S. that can really operate with that sort of breadth and scale helping companies at early of stage and also being able to help partner with them as they become really large and complex. All right. You need a trusted advisor. Taxes accounting. You don't want to play games of this stuff.

Starting point is 00:40:44 Get it right. Get a great partner like CLA. go to clyacconnect.com slash tech and let them know your boy jakel sancho once again cly connect dot com slash tech Dave Clark I got a front row seat to this because I started inviting I asked my team you know we're doing this liquidity conference in Napa we used to call it the angel summit but since we became more of a fund than an angel and syndicate we rebranded at this liquidity conference the summit and we had a list of like vCs who we refer our founders to so we just decided we'd email them and they did it from my email address all of a sudden I get all of these responders. I'm no longer with this firm. I'm no longer with this firm. This person's

Starting point is 00:41:19 no longer at this firm. And I was like, whoa, that's a lot of people no longer with firms. I don't know if either of the Davids are seeing a lot of VCs like move to venture partners or move out as the, because, you know, the, the, the, usually the management fees go from whatever, two and a half down to two and a quarter to one point five, one percent. It's just not going to be the money to pay these GPs, right? Yeah, I think we've seen, you know, a small number of, you know, what I would kind of call sort of senior partners, you know, decide that, you know, now's the time for them to kind of step to one side a little bit. And, you know, don't want to be doing this, you know,

Starting point is 00:42:01 for the next sort of fund cycle. And if that's managed well and there's an organization behind them and a team behind them, then that's fine. You know, I think one of the things that VC generally doesn't handle properly as succession. So, you know, to see some of the senior partners, you know, take a decision that they want to move sideways and, you know, still be involved in some capacity, but not be the kind of, you know, one of the main deal doers, I think, I think makes sense. The other thing that we've seen is a little bit of attrition at the junior levels as well, where, you know, people actually realize that VC is not just about going and, giving, you know, writing checks to your friends and being everyone's favorite person. It's about, you know, really grafting and working hard and oftentimes, you know, having to deliver bad news. So, you know, I think that, you know, we are seeing, you know,

Starting point is 00:42:57 some people that got into the industry as a first job or a second job over the last few years decide that actually this is not what they want to do long term for their career. It is definitely, you have to have a certain personality. type. I find to do this job well, you have to be super positive and optimistic and, you know, really be able to deal with challenges. And at the same time, like you're saying, deliver bad news. Hey, we're not doing the next round. Hey, we're not, we don't do bridge rounds or, hey, you know, we need to talk about, you know, replacing you as CEO or firing your co-founder or whatever hard discussions are going on at the board level. And just, I find one of the, when we hire research,

Starting point is 00:43:42 and analysts. I have a program what I call RAAs. Researcher Analyst Associates. I don't hire associates anymore. I only hire researchers. Get them to 500 first meetings. Then when I make them an analyst after a thousand meetings, then they qualify as an associate, which means you're doing four meetings a day, three meetings a day. You know, call it 15, 20 meetings a week. You know, you can get there in a year, no problem. Um, or two. But just saying no. to good companies waiting for a great one. I find some people can't handle that. It's just two, and I have to sit them down and have like a talk with them.

Starting point is 00:44:20 Hey, our job is to meet with 200 companies and pick one. Like, that means $199. And by the way, you sorted through half of them. You didn't even take the meetings. So you sorted it through 400. You met with 200. We invested in one. That's like a hard.

Starting point is 00:44:37 That's hard personality. That's like going on 400 dates to pick one person. to marry, but that's probably a good idea, you know? Yeah. And there's a 90% chance that the one that you pick isn't going to work out as well. Yeah. There's your reward. Congratulations. You did 4,000 meetings to make 10 bets or 2,000 meetings to make 10 bets and one worked. And the rest of the sentence. I'm literally, this past year, I cannot tell you how many companies I just had to talk with the founders about the wind down. And man, I feel like your whole reputation in this business is determined by how you do hospice care.

Starting point is 00:45:19 Like I had to, somebody was selling a company who's going to be like very poor of returns for everybody. And I just said, listen, you got, you got a return. Let's, you know, do your time at this acquirer. Do a great job. And let's focus on your next company in two years when you get your earn out. But man, I don't know. Tamash, what is your take on the, on the personality type and your own

Starting point is 00:45:41 personality in relation to what works in venture? Yeah, I think there's probably two different archetypes. One is like you said, an optimistic grinder, right, where you're just meeting lots and lots of companies. You have basically infinite patience because feedback cycles are decades. And then I think there's another type, which is a person who comes out of industry and has a really strong network. And as they said, like, bets on all their friends and actually it turned out to be

Starting point is 00:46:10 pretty spectacular. So I think, I mean, there are many others, but those are sort of the two domiciles. Tomas, when you started at Red Point, were you advised to take a bunch of meetings before you make a decision? It took me two and a half years to make my first investment. It was a really long time. I, candidly, I had no idea what I was getting myself into. I was a product manager at Google before, and I had this, didn't even know venture capital

Starting point is 00:46:37 was a career before I came to California. And just could put it fell in over the idea that you can learn about new technologies every day. But as we all know, there's a lot more of the business than that. And it took me a really long time to understand. You know, and it was at a time when the firm was investing in many different things. I remember our first day, first company was a commercial LED company. The second company was a clean tech business. And the third was an on-prem software company.

Starting point is 00:47:03 So like the number of spaces we needed to cover or just get up to speed to have a strong point of view or much And you can be right. This is the most frustrating thing I think about this career is you could be right about your thesis. Hey, we know AI plus, you know, professional services, legal, tax, whatever is going to be big. Hey, we know mobile photos and sharing is going to be big. And you pick color instead of Instagram. You pick some video site, you know, you pick sidecar instead of Lyft instead of Uber. And that is, I think, could be soul crushing. You know, you figure out where the future is, but you place the wrong bet. And you came so close to it. Somebody, I was watching Gary Vaynerchuk, Gary V, and he said every now and then he opens up his email from Brian Chesky at Airbnb and just stares at the fact that he didn't even reply, you know, and he just stares at it. And when I introduced 21 people to Uber, I remember Mark Suster was in the room and he couldn't get there and he missed the investment. And, And to this day, Mark and I are in a couple deals together.

Starting point is 00:48:13 He just shakes his head sometimes. He's like, oh, man, how did I miss it? This is a $4.5 million round of Uber he missed. And then there's other people, you know, I find another interesting thing about the psychology of all this. You know, you hit some giant win, like some of the Facebook investors. It's very hard to get out of bed again and betting on companies knowing there's a very unlikely chance you're going to hit another Facebook.

Starting point is 00:48:37 You're just statistically, you hit one. of the top five companies of all time, you know, they're, they're, they're, it's, it's in the fang. It is the fang. It's the first letter of the fang, right? Um, and you just, you're, you're not going to do it again. That's got to be hard. That's like, I won a championship. I'm never going to win another one. Can you imagine you're LeBron and you're like, there's no chance to be winning. So I got to get up and suit up for basketball every day. Hard to do. Yeah, even a typical salesperson, like a really good salesperson will close one in five deals, mediocre salesperson, Michael's one in 10 or one in 20.

Starting point is 00:49:12 And then in venture, like we said, right, it's like one at 200, one in 400. Yeah. If you're listening to this and you're a young person, don't take this job. You've got to be unreal. It really is like a survivorship bias. People look at the people who made it work and got to their second decade. And they're like, ooh, I want to be like them. They just don't see all the people who did it for six months, six years and quit.

Starting point is 00:49:36 And we're like, I'm never going to get those years back. You know, I should have just started a gum. The world needs less venture capitalists, less capital, and more entrepreneurs and more talented people on the management teams. For some reason, this job got super popular over the last decade. It shouldn't be as popular as it is, I don't think. I don't know what you think, Dave. It's too many VCs, too. Yeah, I think it certainly feels like that.

Starting point is 00:50:00 At the same time, you look at the sectors where technology is having a major impact now. And it's just the opportunity set is so large, you know, so much. order and so much deeper than it ever has been. And so, you know, clearly the amount of capital that the industry can consensibly consume is bigger than it was 10, 20 years ago. And the number of firms it can sustain is larger than it was 10, 20 years ago. But it certainly feels that over the last two or three years, we've kind of overshot the out of where we should be.

Starting point is 00:50:34 And so I think it's inevitable that we'll see some kind of reversion to the mean over the next couple of years. I think there is an efficiency in the market. You shouldn't have 6,500 managers, and I think that's highly correlated with the fact that so many of them are not able to do another round. I do think we need, at least as many VCs, we should just be investing much more earlier stage. A lot of the talent has now gone upstream. It used to be that the large funds did seed fund, seed checks. Now they do series A checks.

Starting point is 00:51:07 And as those multi-stage funds continue to grow, they're going to be concentrating their talent in the later stage. So I do think having a healthy early-stage ecosystem from the emerging manager standpoint is very healthy both for the ecosystem, but also for new startups. Think about all these companies. Jason, I know you helped calm when they were almost going to die. and if you hadn't been there, if they didn't have the incremental seed investor, they may not be the behemoth that they are today.

Starting point is 00:51:38 So I think having a lot of capital, almost by definition, having enough angels and early stage capital is something that's really positive for the ecosystem. I think that's like, Tomash is like kind of proof that like a concentrated portfolio

Starting point is 00:51:54 is like an easier thing to manage because you're picking people with a greater chance of success, with more of the questions answered than at the level Gary Tan's doing or I'm doing or other folks. And then between us is probably para VC or 500 startups or 500 global tech stars, whatever.

Starting point is 00:52:16 And it really is hard at that early stage to deal with a number of companies going into business. So I've had to come up with a methodology or maybe even a philosophy, a life philosophy of how I talk to the founders, right? And I just tell them, like, listen, if you lose 125K that we gave you for 7%, it's okay with me. I just want you to promise me that when you do your next company, we get to be the first investor. And I have that conversation over and over again with them.

Starting point is 00:52:45 And you know what? When Raul did superhuman, he came to me and said, hey, you know, you did report of, you know, you put 50K and we gave you back 250 or something. And you had said, hey, let me know when you do your next one. And he came back to Darmesh from HubSpot of myself. and we were the first two investors in superhuman. And I think he says like Darmesh, he tells Darmesh he was first and he tells me I'm first. Well, he's pretty good about that. But you know, you have to be built for it.

Starting point is 00:53:10 You have to be built for, you know, whatever the amount of, you know, zeros there are. And, man, I can tell you as a high stakes poker player as well, that's what's taught me a lot about this. When you lose a hand that you're supposed to win, you know, you're a 70, 80 percent favorite, but the 20 percent comes in, you have to. you have to get your brain chemistry used to this possibility. I think it's why a lot of people, when Trump beat Hillary Clinton, not to bring up Trump twice in an episode of liquidity, but when he beat them, people were like,

Starting point is 00:53:39 got mad at 538 or whatever, and they were like, how did you get these statistics wrong? And they're like, no, we told you it's a 36% chance of winning. It's a one in three. You just didn't believe us. And you don't understand basic statistics. So I think you have to learn how to take, losing and zeros and really like get comfortable with it.

Starting point is 00:54:05 And it's taken me a decade. I have to say, like, I used to get very tweaked by losing. Even to this day, I get really upset about it sometimes. And it's really something I have to manage my own psychology. Managing your own psychology and gambling, which is what we do.

Starting point is 00:54:19 We're placing bets. Let's be honest about what it is. You know, David's placing bets on GPs. GPs are placing bets on founders. Founders are placing bets on markets and customers. We're all placing educated bets. And this is why poker is so popular amongst investors and so important because you have to learn to lose. And when you win, when you're not supposed to win, you get lucky.

Starting point is 00:54:39 Or when you lose when you're supposed to win, you get unlucky. Understanding this, taking it to heart, but then still being able to improve your process, because that's all you have. And you know, Dave, when you were on the episode, we talked about your terrific 12. And I think that's what it's right. It's terrific 12. I dubbed them. Yeah.

Starting point is 00:54:57 Yeah. Like your discipline, that was what I took away from it, your discipline of adding these managers very slowly, very thoughtfully. And, like, maybe you could unpack that here and just explain how you pick managers and how thoughtful you are about it. Because I do think the psychology of how you pick managers and saying no to them, you know, I don't think you're in Tomosh's or my fund. I don't know. You could be in Tomasas. I don't know. Maybe you picked him over me. But you're not adding that many. So I don't take it personal that you're not in my fund.

Starting point is 00:55:27 Just like, I don't think a founder can take a person that I'm not in their startup, right? We already said, $199 we don't go into. Yeah, I think it's really interesting. And, you know, Tom Ash, what you were saying about the scenarios that you ran and, you know, where you ended up in terms of, you know, what you thought the best parts of the market to play in, the, you know, the focused early stage or slightly broader kind of growth stage. In a way, we've sort of done that, done something similar, not through running a series of models, but through actually investing over a 30-year period. And I think part of it as well is

Starting point is 00:56:02 aligning with where we are as individuals and the level of risk and the level of uncertainty that we're happy to take and the types of risks and types of uncertainty that we're happy to take. Because I think one of the characteristics of venture is there's still a high degree of randomness. And the earlier you get, the higher that degree of randomness is in each individual decision that you take, whether that's as a GP or whether it's as an LP. And I think for us, we found a level where we're comfortable with the risks and it allows us to consistently produce the sort of returns we need to do in order to add value for our investors. And so I think finding that where psychologically you're comfortable, but where you're still able to perform

Starting point is 00:56:49 at a high level is really important. And for us, it just comes down to, you know, we know, Ventures are power low industry. We know it's the top 1% of companies that deliver the majority of the exit value. And so, you know, we have a very simple screen, which is every time we look at a manager, we ask ourselves, you know, how many top 1% companies have they backed? What was their role in doing those deals? You know, were they invited in? Were they a bystander? Were they actively leading that deal? You know, have they been able to do that multiple times? And the more times that we see them invest in those top 1% companies, the more confidence we have that they'll be able to repeat that.

Starting point is 00:57:29 And David, your model allows for a bad vintage from time to time or sub-average, knowing that it's probabilistic in nature. Yeah, absolutely. You know, you're always going to have good managers who, as you said before, you know, they had the choice over company A, company B, they got the macro thesis right, they just chose the wrong company for whatever reason. And that's always going to happen. And so I think for us, you know, understanding.

Starting point is 00:57:53 that just because you have a bad fund doesn't make you a bad manager is really important. Now, we want to make sure that the manager has really examined the reasons behind that bad fund. Was it just a case of choosing company A over company B or were there structural reasons behind the fact that that fund hasn't performed? In some instances, you know, you do find their underlying structural reasons and then you want to have that conversation and make sure that they're addressing them. But even the very best firms go through periods of, you know, that where where things don't always work.

Starting point is 00:58:30 You know, you look at, you know, some of the challenges that Sakaya's faced over the last sort of 18, 24 months. You know, are they performing as well as they've performed historically? You know, you could argue, you know, perhaps they're not. But, you know, would you argue that they've got the people there that are going to fix that? And, you know, would I bet on them to, you know, to be in a much better position in 24 months? time, you know, absolutely. I think they absolutely will. So I think you have to recognize that, you know, the path of a venture firm isn't, isn't always like that. There are, you know, significant ups and downs. And it's how they navigate those challenging times that ultimately,

Starting point is 00:59:07 I think, leads to the really sustainable franchises developing. I couldn't agree more. You know, it's really like thinking about how you make decisions. like really examining how you make decisions is like a very meta concept, Tomash. I'm curious how you examine your own betting and your own thinking about betting and your own thinking about portfolio management. Like how often do you examine it and think, am I doing the right thing? Is 15 the right number? Or should it be 25 or should it be 10 or should I, you know, how do you think about thinking and your betting strategy and your portfolio strategy? Yeah.

Starting point is 00:59:49 Well, we evaluated the portfolio construction every time we raise a fund and update the priors. That's really important. And then in terms of the decision-making process, we run the firm with six different roadmaps. And one of those roadmaps is actually improving the investment process itself. So we capture structured votes. We have quantitative research on companies that we do. And then every quarter, because we're so concentrated, we need to update our reserves. So we run probabilistic scenarios for each of those companies to determine where we think future dollars will go.

Starting point is 01:00:23 And I think, you know, Big Driver, we maintain a lot in reserves. And so if we, a typical Series A firm might have a 60, 40 initial dollars invested 40% reserve split. So if it becomes really important to think about those reserves because basically half the fund. And there's a bunch of research out there coming from out of Stanford on portfolio management. It turns out you can actually move a fund from top quartile to top desktop with active reserves management. So that's a really important part of how we think about driving great returns. So you're looking at those 15 and saying of those 15, which two or three, 10%, 20%, deserve the final 50% of the dollars? Yeah, it will change on it

Starting point is 01:01:12 As a function of what's happening Within the underlying portfolio But the idea is We have to be actively managing those reserves Because that's what we'll drive Because it's basically to have to find To follow up questions How do you communicate that to the 15 founders

Starting point is 01:01:27 And founding teams That they are or aren't in that group, right? And then have you done preemptive Where you say, hey, I know this is a winner I think this is our Uber I think this is our Coinbase, whatever it happens to be, and then say to them like Sequoia did with WhatsApp, hey, would you like more money and preempt them from doing around?

Starting point is 01:01:46 So you take that in either order. Yeah, so I've worked with a bunch of companies where we preempted one company, crampeded the C, cramped to D.A. In fact, it's all more close to 60 to 70% of investments we've made so far, preemptions. Wow. Yeah. And that's because we do all that research, we prepare, and then we try to put ourselves in a position where we can invest before the company

Starting point is 01:02:08 goes out to market. So you spend more time studying your existing portfolio than new deals? Is that correct for people? The preemptions are in net new companies rather than existing companies. So we're only a year in. So we're not yet in a position to be able to preempt a lot of the internal portfolio. But the idea is the same. I have to build a big body of research and then.

Starting point is 01:02:31 How do you think about communicating that to founders or do you communicate it to founders yet? Like, hey, we have reserves, but here's how you qualify for them. Yeah, we're really clear. We're really clear on milestones. We set up internal plans for those portfolio companies where we expect them to be. And as you said before, Jason, like the way that you communicate and articulate the candor is your reputation in the history. Yeah. David Clark, how do you think, how do your terrific 12 think about reserves and think about communicating to their portfolio?

Starting point is 01:03:04 Do you get that deep in the weeds with them? Yeah, certainly on the reserve side, I think, you know, the reserve equation has changed, I think, over the last 10 years as more of those firms have raised separate growth vehicles. And so to some extent, we've seen reserves in early stage funds reduce because they kind of see the growth funders as filling that. Why is that? And is that the right way to do it? Or should it just be in one fund for simplicity? How did we get here? I'm curious.

Starting point is 01:03:40 Yeah, I think we got here because companies are staying private for longer. And I think there's a different return profile that can be built by investing in later stage businesses that can still deliver on aggregate attractive risk-adjusted returns. But it's a different risk-return profile than what you would actually. from early stage. So I would say that, you know, if you look at the variability of outcomes for a growth fund, it's a much tighter ban than you would get for an early stage fund. That's not to say, you know,

Starting point is 01:04:18 the best performing fund we've invested in over the last 15 years has been a growth fund, which is doing 15X. They hit something. What did they hit? They must have hit something. That's like hitting a royal flush or something, right? What did they hit? Yeah, yeah.

Starting point is 01:04:31 Yeah, they hits probably the, the most valuable private company in the world today. Stripe. The hit Stripe, okay, got it. Not necessarily in the U.S. Oh, okay. Wait, wait, so wait, wait, who's the,

Starting point is 01:04:48 oh, Adyen. Would be Adyan, yeah. Contemporary maybe. Is that the top two privates? I don't know, David, you would know. The other David. I think Saudi Aramco, but I'm guessing they didn't invest into that way.

Starting point is 01:05:02 Yeah, no, I don't think they got into LVM. for Saturday Ramco. No, no. So I think going back to the reserves question, for us, it's, you know, being able to deploy that capital sensibly is really important. And when we look at our data, what we find is the best managers can actually reduce their exposure to the loss-making companies and increase their exposure to the 5x, 10x fund returning companies.

Starting point is 01:05:27 And if you're able to do that successfully, then, you know, you are having an impact on on the initial bets that you made. So I do think being able to manage your reserve strategy effectively is one of the areas of being a really successful VC that perhaps doesn't get spoken about as much. And I know I've had conversations with a number of emerging managers and seed funds who don't want to do any reserves at all and see it as diluting the initial check. And interesting, Tomash, that you were talking about some research that you've seen there that can, you know, can push funds into the top decile if they do it properly.

Starting point is 01:06:07 That's certainly the sense that that we've had when we look back at the data from the 500 plus VC firms we've invested in. Is there a magic number, David? Have you, have you segmented by Reserve Strategy and TVPI? No, no. We haven't got that level of granularity. Well, what's your intuition tell you? What's the magic number?

Starting point is 01:06:29 Yeah. I mean, certainly, you know, we've seen, you know, something around a 50-50, 40-60, 60-40, that sort of thing is historically what we've seen. I think there are firms that have done well more recently where they've been 70, 30, even 80, 20, but where they have that growth vehicle. And the growth vehicle, just to be clear, the growth vehicle will do the best companies from the early stage funds, but it will also do net new companies as well. So it's not necessarily just looking at making those follow-on investments.

Starting point is 01:07:05 Yeah, I'm going 50-50. You know, when I looked at my first fund, which was, you know, 5X on paper, we've turned 1X already. And we had Robin Hood, superhuman, calm, and density in there, density. Atio, and three out of those four, we knew were definitive winners. And we didn't have reserves to double down on them. We didn't just consider it. It wasn't considered. You were just like, you get a $10 million fund.

Starting point is 01:07:27 You make 100, 100-gabets or something in that range. and now I'm just like, you know what, $50 million fund, $25 million into, you know, 100K, 250K bets get whatever number of names that is and, you know, 200 names. And then the last $25 million into the top 5% of that. And then we've had to communicate that. We are not, we don't do bridge rounds. We don't do our pro rata unless it's in the top 5% of our portfolio performers. And we'll just tell founders like, listen, you're not the one in 20.

Starting point is 01:07:57 here's where you stack rank and for us to be involved we would just need to see a little bit more and it's a competition for those dollars so I just tell people it's a very small amount a very small number of people are going to get those reserves and it's a competition for them that's it you know not everybody gets a max contract

Starting point is 01:08:15 in the NBA either not everybody gets the $40 million super max contract a year in the NBA so and that's okay doesn't mean you're not going to be successful but man I find that a lot of VC firms are not clear with their portfolio companies, how they do reserves. And I've seen this really send founders into a tizzy.

Starting point is 01:08:35 Perhaps right, Felisa? Perhaps, you know, perhaps all is fair in investing. But, you know, they just think, oh, well, this VC fought for this deal. And then when things get hard, the VC is going to do their bridge round. And they're like, yeah, I mean, I remember Chama from Social Capital just had a rule. We don't do a bridge round. We only do price rounds. So if you do a bridge round, that's fine.

Starting point is 01:08:57 We're just not participating in it, but when you get a priced round and somebody's leading it, then we'll consider our pro rata. And I thought that was very crisp and clean language he gave to some of our portfolio companies. Let's move on to our lightning round where we'll dive into the top three investments from each of our guests. Tamash, you're up. Yeah, there's three companies I love to mention. One is a company called Mother Duck, which is Next Generation Database Company, founded by the tech lead from Google BigQuery, are involved in the seed and the A.

Starting point is 01:09:27 And that big open source traction, completely different architecture in one of the biggest software markets, which is the analytical database space. And really, offices are full of rubber ducks, so if anyone ever gets a chance to go visit. Fun branding. Yeah, they've done a really nice job. The second company I'll mention is a business called Omni.

Starting point is 01:09:48 And I was looking enough to be on the board of a company called Looker, that Google bought for about $2.6 billion. and they were building a VI tool. This is a part of the core team from Looker, who's going about it a second time and taking some of the control mechanisms from Looker and the administration and balancing

Starting point is 01:10:05 with the flexibility of Tableau. So it was involved in the C and the A and just involved in the next round too. And then the third one, just real quick, is a business called Arbitrum, which is a Web 3 company founded by a team from Princeton that wrote many of the core papers underneath E-Pripto and

Starting point is 01:10:24 reasonably worth about $20 billion and they process more transactions in both count and dollars than Ethereum, even though they're actually on top of these theory. Fantastic. Really interesting choices. I notice, you know, really

Starting point is 01:10:40 seasoned teams there, huh? Really. Yeah, you're right. Actually, that's a theme across these three. Very seasoned, yeah. You know, I'll give you some fun ones here. So we, you know, we've made some of these 25K bets in our founder university.

Starting point is 01:10:55 And we like to make these small bets on odd, weird ideas, knowing that maybe they'll make it to the next stage again. This one newcomer is pretty funny. Guy obsessed with video games. Teaching language in video games, I don't think I have the sound on here, but you can see as you play this game, you know, it's like du lingo,

Starting point is 01:11:14 except you're playing a game. And instead of doing, you know, choices in your native language, you learn how to say farmer in Spanish or, you know, Greek or whatever, you're doing it in. And, you know, people seem to love it. And it's getting some nice traction. This one, I thought, was very interesting called recall. Browser extension, everything you browse, you know,

Starting point is 01:11:40 reminded me of delicious or other bookmarking tools. And as you bookmark things are interesting in whether it's a PDF or a document that was sent to you in your email or a web page or a YouTube. video, a podcast, puts it into your knowledge repository, and then you can start asking questions of it. The more you use it, more knowledge. So it's like your personal LLM, and we'll see where they take it. But you can take any of these pages that you meet. And the one feature I said was, can I just automatically turn this on?

Starting point is 01:12:08 They'd be like, it'd be very expensive. And I was like, yeah, you make a version for Wales where it's $500 a year. Every webpage I do is indexed. And then, Pod Engine, you know, I'm obsessed with podcast. trying to track all the discussions going on really hard to do, right? And you know that we've had some interesting conversations here about very granular topics. And so if your company was mentioned or a topic, you know, getting that intelligence out of podcasts, summarized and into your email box or into a boardroom meeting, very hard to do.

Starting point is 01:12:45 And so this pod engine is basically indexing the world's podcasts and letting you track things and search them. And so this is something where people will pay a lot of money for this. And so we're very excited about those three. And they're fun and interesting. Consumers hard, but, you know, when you do hit on consumer, some of my biggest hits, RomHoodcom and Uber, obviously, Thumbtack, a lot of consumers in there. And David, I know you don't share manager names, but you had a couple of recent investments. Yeah, so we're just about to close on a couple of funds from a pretty large brand name firm. So that's covering early stage in growth.

Starting point is 01:13:24 And we've been investors with them since 2012. I think we started with Fund 3 with those guys. The last ones we've actually closed on was at the end of the last year. Again, that was an early stage and a growth fund. So I think it was Fund 8 was the early stage. Fund 5 was the growth one from another established manager. This manager was, they were one of the early investors and one of the big social media companies in the kind of 2000.

Starting point is 01:13:48 thousands have done some really interesting sort of hardware deals that have ended up as fund returners. And again, we first did them at Fund 3 and have been investors there since 2010. And then the one before that was an early stage fund from one of the top three or four global BC brands. And funnily enough, we were with them from Fund 3, but that was back in 1994. So that's a 30-year relationship we've had with those guys. So sorry, I can't mention specific names, but... David, how does someone become your 13th fund? I'm going for 15.

Starting point is 01:14:25 I don't want to be 13th or 14. I'm going for 15th. Fund 5. I'll see you in two years with some good data. Yeah, we are. There's a couple that we're looking at adding. And I think it just goes back to what I was saying earlier. It's about wanting to make sure that we're seeing firms that have got that history of

Starting point is 01:14:47 being able to, you know, identify those top 1% companies, access them, you know, win the deals, add value and be able to structure exits around it. And also, we do think that venture is a team sport. And so, you know, we like to see a depth in the team. And, and, you know, where, you know, there are some fantastic, you know, solo GPs, individual VCs out there. But I think, again, from our kind of risk profile, you know, we like to see that we want to back a team. And so, you know, we're looking at the sort of depth of the team. There can be strong individuals within that team. That's fine.

Starting point is 01:15:23 But I think we, you know, we want to get comfortable that there's a group of people there that are, you know, that are working well together, that are feeding off each other and where the, you know, the sum of the parts is greater than, you know, the individual bits. That's great information. What a great episode. Get us out of here, David. It's been another fascinating episode with two brilliant guests on the liquidity podcast for Tomas. Tongass, David Clark, Jason Kalicanis. This is your host, David Weisbert. Thanks for listening.

This Week in Startups - Tomasz Tunguz and David Clark on how to invest in AI and Q1 2024 startup valuations | E1930

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.