20VC Roundtable Is the VC Model Broken The Biggest Disconnect Ever Between TVPI & DPI, Why Market Size is Dangerous, Why Go Fast is Terrible Advice, The Dangers of Raising Large Rounds at High Prices & Why Next Year Will See the Biggest Hiring Spree i

Summary Notes


In a dynamic roundtable discussion on "20 VC" with host Harry Stebbings, top seed investors Eric Paley (Founder Collective), Mike Maples (Floodgate), and Jason Lemkin (SaaStr) delve into the evolving venture capital landscape. They debate the implications of high valuations, the pitfalls of overcapitalization, and the importance of non-consensus investing. Eric highlights the risk of early-stage companies being overpriced, which can hinder future fundraising, while Mike emphasizes the necessity of identifying unique opportunities that others overlook. The panel also discusses the potential disconnect between paper valuations (TVPI) and actual returns (DPI), the role of patience as an arbitrage, and the challenges of macro investing in a venture context. Despite differing perspectives, they agree on the significance of building intrinsic value and the long-term journey of venture investments.

Summary Notes

Non-Consensus Investing

  • Outliers in investments often begin with low valuations because they are non-consensus and right.
  • Non-consensus ideas are those that are not yet popular or widely accepted in the market.
  • A non-consensus investment strategy involves backing entrepreneurs with unique, contrarian insights that have the potential to be correct.
  • Being non-consensus and right has historically led to large exits, as seen with companies like Pinterest, Airbnb, Dropbox, Uber, and Lyft.
  • High valuations at seed stage can be problematic, as they imply consensus belief in success, reducing the potential for outsized returns.

"You have to be non-consensus and right. Investing in an entrepreneur who's non-consensus and right, and a lot of people say, well, that's changed. Look how big these exits are. But then when I look at those big exits, they all had low prices. Pinterest, Airbnb, Dropbox, Uber, Lyft."

This quote emphasizes the importance of investing in unique ideas that are not yet widely accepted or priced into the market. Successful companies often start with lower valuations because their success was not a consensus belief at the time of investment.

Ownership and Capital Efficiency

  • There is a disconnect between traditional venture capital performance indicators like Total Value to Paid-In (TVPI) and Distributions to Paid-In (DPI).
  • The venture industry has experienced a period of "apathetic capital," where investors are less concerned with ownership and more focused on deploying capital into trending sectors.
  • Overpriced seed rounds can lead to difficulties in raising subsequent funding, particularly Series A, if the valuation is too high relative to the company's progress.

"We do not focus on ownership. I think we've had a period of quite apathetic capital. I would bet the last few years will be one of the biggest disconnects between TBPI and DPI for venture funds in venture history."

The speaker suggests that there has been a lack of focus on ownership stakes in startups, leading to a period where capital is deployed without sufficient concern for the value created. This could result in a significant difference between the paper value of investments and the actual returns realized.

Venture Suitability in B2B

  • There is skepticism about the effectiveness of venture capital in the B2B space.
  • The traditional venture model may not align well with the capital-intensive nature of some B2B companies.
  • The venture capital industry is cyclical, with good times to buy and sell, but rarely both simultaneously.

"I actually don't think venture fully makes sense in B two B at Co. I generally don't think it works."

This quote expresses doubt about the compatibility of venture capital with B2B companies, suggesting that the model may not be optimal for this sector.

The Role of Seed Investors

  • Seed investors are expected to take chances with entrepreneurs before the market is ready to do so.
  • The seed stage is about demonstrating proof of concept and providing evidence to support the entrepreneur's thesis.
  • Seed investors generate value by identifying and investing in companies with the potential for significant growth before they become widely recognized.

"We exist as investors in seed to take those chances with those entrepreneurs before the rest of the market's ready to take those chances. Like, that's where we generate alpha, in my view."

The speaker highlights the role of seed investors in taking early risks with entrepreneurs and generating returns through these strategic early-stage investments.

Capital Intensity and Seed Funding

  • Some industries, such as AI, require significant capital investment early on, which may not align with traditional seed funding models.
  • Seed investors must be selective and focus on opportunities that align with their capital structures and investment strategies.
  • The pursuit of non-consensus opportunities remains essential, even in capital-intensive fields.

"But can we, Mike, when it costs? I had the founder of character AI on the show and it cost $2 million to train a single model. They needed tens of millions of dollars to get off the ground. Is it even possible for traditional seed to play in that world where the capital prime is so much so early?"

This quote raises concerns about the feasibility of traditional seed investment in industries that require substantial capital early on, such as AI, where the cost to train a single model can be millions of dollars.

  • There is a belief that we are currently experiencing an AI investment bubble, with a significant amount of venture capital flowing into AI startups.
  • The popularity of AI may lead to inflated valuations and a focus on narrative rather than substance.
  • Despite the trend, investors must remain disciplined and seek genuine, non-consensus opportunities rather than following the hype.

"I think if you're describing bubble as the asset prices related to that general idea, I think we're in a very extreme bubble."

This quote suggests that the current enthusiasm for AI investments has led to inflated asset prices, indicating a bubble in the AI sector.

Hiring Ahead of Product Market Fit

  • Hiring too many employees before achieving product market fit can lead to pursuing losing ideas for too long.
  • Having fewer resources forces a focus on getting product market fit and eliminates distractions.
  • Overstaffing can lead to developing an excessive product footprint that customers may not want.
  • A lean team focused on customer needs is more advantageous for achieving product market fit.

"And so what I saw happening was, I have the money, I might as well spend it. I can get these great engineers. I've known them, I know what they're capable of. And before you know it, you develop too much product footprint, too soon, too opinionated."

This quote emphasizes the pitfalls of hiring too many staff members before a company has product market fit, leading to the development of an overcomplicated product that may not meet market needs.

Product Market Fit Spectrum

  • Product market fit is a spectrum, and not all companies need to have perfect product market fit to be successful.
  • Companies with moderate product market fit can still succeed if they have strong go-to-market strategies.
  • Overcapitalization can lead to accelerated growth without fixing fundamental issues, causing diminishing returns and performance decline.
  • Bad capitalization is a significant risk for venture-backed companies, sometimes more so than undercapitalization.

"But I think what's tricky is those five to seven or five to eight scale product market fits where something's working. It's working nicely, but you are reliant on really good go to market."

This quote acknowledges that moderate product market fit can lead to success, but it is heavily dependent on effective market strategies and the avoidance of overcapitalization.

Business Model Fit vs. Product Market Fit

  • Some companies may have product market fit but lack a viable business model.
  • Product market fit should answer the question of what a company can uniquely offer that customers are desperate for.
  • Overfunding before identifying customer desperation can lead to selling to the wrong customers and hinder sustainable growth.

"When it comes to product market fit, I'm pretty strict. My view is that product market fit answers a very important but profound question, which is, what can we uniquely do that people are desperate for?"

This quote defines product market fit as the alignment between a unique offering and customer desperation, highlighting the importance of identifying a strong market need before scaling.

Misaligned Venture Capitalist Expectations

  • Entrepreneurs often face pressure from venture capitalists to grow quickly, sometimes at the expense of learning and understanding customer needs.
  • The push for rapid growth can lead to missteps and a focus on short-term gains over long-term value creation.
  • There is a disconnect between the patience needed for finding true product market fit and the fast-paced expectations of some investors.

"I have had so many of our entrepreneurs say to me, when I talk about the kind of patients Mike's talking about, they say to me, well, my other vcs are pushing me to go faster."

This quote highlights the tension between the patient approach needed to achieve product market fit and the pressure from some venture capitalists to accelerate growth prematurely.

Blitzscaling and Its Misapplication

  • Blitzscaling is a strategy that works in rare cases where product market fit is so strong that the market demands rapid expansion.
  • The concept is often misapplied, leading companies to scale too quickly without the necessary market pull.
  • The lean startup methodology and blitzscaling are not one-size-fits-all solutions and are often incorrectly implemented.

"I think blitzscaling is this beautiful, beautiful idea of exactly what Mike said applied wrong in almost every context."

This quote criticizes the widespread misapplication of blitzscaling, suggesting that it is only suitable for exceptional cases of strong product market fit.

Market Dominance and Enterprise Value

  • Market dominance can significantly impact the enterprise value, but predicting market outcomes is challenging and often inaccurate.
  • Venture capitalists should focus on founders with clear solutions to customer problems rather than attempting to predict market size and dominance.
  • The narrative of market size can lead to missed opportunities if investors overemphasize potential market value over the founder's vision and execution.

"I don't spend a lot of time going, well, is it only a $3 billion market or is it a 200 billion dollar market? It's a very dangerous model that makes you talk your way out of. What would you say was a market for Pinterest?"

This quote stresses the importance of backing founders with compelling solutions over trying to calculate the potential market size, which can be a misleading factor in investment decisions.

Seed Investing and Price Sensitivity

  • Seed investing requires a balance between price and risk, with a direct relationship between the two.
  • Paying a higher price at seed stage implies a higher tolerance for risk, which should be justified by significant risk reduction.
  • Seed funds need a diversified portfolio and enough investments to increase the chances of finding successful outliers.

"Like, the higher price you pay, the more risk you're tolerating by paying that high price, and the more risk takeout you should expect to justify that high price."

This quote explains the relationship between price and risk in seed investing, emphasizing that higher prices should correlate with lower risks, which is not always the case in practice.

Venture Capital and Founder Mindset

  • Founders often lose perspective on the risks involved in raising subsequent rounds of funding.
  • The process of venture capital fundraising has been gamified, with founders focusing on raising large amounts rather than the inherent risks.
  • Founders inherently believe in their success, making it difficult to consider the possibility of failure.
  • The mindset of winning and optimism is necessary for founders, even when facing doubts.

"Think founders have lost all perspective on the risk they're taking in the next round. I genuinely believe it's been venture has been so gamified the last five years and everyone's to blame, everyone's to blame."

This quote emphasizes the disconnect founders have from the risks associated with raising capital, suggesting that the gamification of venture capital has led to a loss of perspective.

"It is unsolvable. I think I remember when I was a founder and I was raising money. People say don't raise at a high price because if things don't go well, you're going to be in bad shape. Well, you're like, I'm going to be the one that wins. That's why I'm doing this."

This quote reflects the founder's mentality of optimism and the belief in their inevitable success, which can overshadow the practical considerations of fundraising.

Investor-Founder Relationship Dynamics

  • Founders may prioritize working with certain investors over optimizing financial terms.
  • The choice of investors can be influenced by personal values and the desire for a supportive partnership rather than purely financial considerations.
  • Founders are willing to accept a lower valuation or more dilution to work with preferred investors.
  • The perception of high valuations and large funding rounds can attract talent but may also deter seasoned professionals who are wary of inflated capital stacks.

"For investors that a founder wants to work with, they will actually accept. You know what? I don't need to optimize. I'd rather work with this investor."

This quote highlights the founder's willingness to compromise on financial terms to work with an investor they value and trust.

"I think it's 20%. I think a great founder will take a 20% lower or delta term sheet to work with someone they really want to work with beyond 20. I think it may be mythical."

This quote suggests there is a limit to how much financial compromise a founder is willing to make, with 20% being a potential threshold.

The Impact of High Valuations on Talent and Product Market Fit

  • High valuations can distract from the core objective of achieving product-market fit.
  • There is a shift in the talent market, with some professionals becoming skeptical of companies with high valuations but little revenue.
  • New hires, especially those new to the industry, often look for signals such as high valuations to make decisions, but these signals may not always reflect the company's true health.
  • Founders should focus on product-market fit rather than raising funds at high valuations to attract talent.

"By the way, this is, I think, another facet of what Eric was describing earlier, the problem of raising too much money, too high prices. It totally distracts you from the real question, are we getting product market fit?"

This quote underscores the issue of excessive fundraising overshadowing the pursuit of product-market fit, which should be the primary goal.

"If you're new to the industry, everyone has to look for signals as a new hire. As a first time, you've got look for signals, right? And listen, we can mock a unicorn round or a deck corn round, but I only get one job at a time, right?"

This quote explains why new hires might be drawn to companies with unicorn status, as they seek reliable signals of a company's potential success in the absence of other information.

The Future of Overvalued Unicorns

  • Unicorns with inflated valuations face three potential futures: becoming real companies, selling at a low price, or failing.
  • Founders may "quiet quit" or "lab quit" if the pressure of high expectations becomes too much.
  • Returning capital to investors may be a viable option for founders who realize they do not have product-market fit.
  • The relationship between founders and investors plays a crucial role in navigating difficult situations.

"One of three things are going to happen to those companies. They're either going to take the extraordinary amount of cash they got, cut their burn rates down, and figure out how to build real companies. And by the way, many of those will still never raise money ever again. But they'll build real companies and find real exits."

This quote outlines the possible positive outcome for overvalued companies if they can adjust their operations and focus on building sustainable businesses.

"I think some of them are actually going to lab quit. I think it's a great era for giving money back."

This quote introduces the concept of "lab quitting," which involves founders stepping back from the relentless pursuit of growth and potentially returning investor money.

Venture Capital Investment Strategies

  • LPs (Limited Partners) must decide whether to participate in momentum investing or seek out investors with a long-term view.
  • The investment climate varies, with certain periods being more favorable for buying or selling.
  • Past investment cycles have shown that momentum investors can suffer significant losses when the market shifts.
  • LPs are faced with the challenge of finding outlier funds to achieve significant returns in venture capital.

"Almost the entire investment world is a momentum investment world and we all have a hard time including, I mean, I think of the big dollar sovereigns are also momentum investors."

This quote discusses the prevalence of momentum investing and the challenges it presents, particularly when market conditions change.

"You have to have a construct. And if you don't allow us, they're all going through some sort of mulliganism because otherwise you can't survive."

This quote suggests that LPs need a framework to navigate investment cycles and may need to give themselves a "mulligan" or a pass on certain investments to maintain their positions.

The IPO Market and Public Company Readiness

  • The obsession with going public can be unhealthy, as it is not always the best path for all companies.
  • Founders should consider whether their company is truly ready for the long-term demands of being a public entity.
  • The initial public offering (IPO) process is sometimes pursued for the wrong reasons, such as prestige or financial sponsors' profits.
  • Strong companies can go public in almost any market environment, and the focus should be on long-term value creation rather than short-term pricing.

"So I have a funny view on ipos that I'm not sure is very popular. But I think there's sort of this, first of all, this obsession with going public that is kind of unhealthy."

This quote expresses skepticism about the widespread desire to go public and questions whether it aligns with the long-term interests of a company.

"I think if you're a strong company, you can go public in almost any period of time, as long as the market volatility is not insane, like the great financial crisis."

This quote suggests that a company's strength and readiness are more important than market timing when considering an IPO.

Short-Term vs. Long-Term Thinking

  • Short-term thinking benefits those who gain in the immediate future, while long-term thinking aligns with value builders.
  • Over-capitalization and overpricing cause problems, but long-term investors should focus on the company's future potential rather than momentary valuation.

"But again, this is all part of the short term thinking of the people who get to benefit in the short term, instead of the long term thinking of the people who really are the ones building value."

This quote emphasizes the contrast between short-term beneficiaries and those who are invested in the long-term value creation of a company.

Venture Capital Strategy

  • Successful venture capital involves recognizing periods of acceleration and knowing when to sell.
  • In periods detached from fundamentals, having enough companies at critical mass and selling at the right time is crucial for massive returns.

"I think a big part of success in venture, for better or for worse, is you have to have enough companies in flight at critical mass in those windows, number one. And then, number two, you have to be smart enough to sell."

Eric Paley highlights the importance of capitalizing on market windows where company valuations are high and detached from fundamentals, suggesting that timing is key in venture capital success.

IPOs and Valuation

  • The valuation of a company at IPO does not need to exceed the price paid by investors if the company has long-term growth potential.
  • The focus should be on whether the company will return value in the long term, not on short-term valuation at the time of going public.

"So the question really is, do you believe the company is ever going to return for you or not? But if the company's ready to be a public company, then sure, you'd rather have access to liquidity when you want it than just have it be private forever."

Mike Maples argues that the true concern for investors should be the long-term return on investment, not the immediate valuation at the time of an IPO.

Company Valuation and Market Dynamics

  • Company valuations fluctuate and should be considered within a range, reflecting the reality of the market's probability distribution.
  • Valuations are influenced by various factors, including growth, profitability, and market conditions.

"I think a very healthy way to think about the value of a company is, and this sounds crazy, but you're going for your series, whatever, series b, and you say, look, the value of this company should be somewhere between 80 and $150,000,000."

Mike Maples suggests that company valuations should be considered as ranges rather than fixed numbers, acknowledging the inherent variability in the market.

Intrinsic Value vs. Market Valuation

  • Building intrinsic value should be the primary focus for companies, as market valuations will fluctuate over time.
  • The use of burn rate to create value is more critical than the dilution caused by financing.

"Focus this is all the sideshow. Valuation is all the sideshow. The dilution isn't even your financing. The dilution is how you use your burn rate."

Mike Maples emphasizes that companies should concentrate on creating intrinsic value through efficient use of resources rather than getting distracted by market-driven valuations.

Public Multiples and the Impact on Venture Capital

  • Concerns about public multiples affecting venture capital, especially in B2B, where mediocre multiples may become the norm.
  • The potential for a cascading effect on venture funding if high-quality companies are valued below $2 billion.

"My concern is that multiples remain mediocre, right. For all but the best."

Jason Lemkin expresses concern that if public multiples do not improve, it could negatively impact the venture capital model, particularly for B2B companies.

  • Hiring in the tech sector is expected to outpace predictions, with cloud spend continuing to grow despite broader economic conditions.
  • The reacceleration in cloud spending could significantly impact company valuations and hiring patterns.

"I think the reacceleration that I see in cloud is happening so quickly."

Jason Lemkin predicts that despite economic headwinds, cloud spending will continue to grow, driving hiring and potentially affecting company valuations.

Investment Decision-Making

  • Venture capitalists should focus on spotting unique, high-potential companies rather than relying on macroeconomic factors.
  • Long-term engagement with a company often leads to better outcomes, as markets will have ups and downs.

"For me, the job is sort of know when you're in the Galapagos Islands and you spot some finch with a weird looking beak that nobody's ever seen before."

Mike Maples uses an analogy to describe the venture capitalist's role in identifying unique companies with high potential, likening it to discovering a new species.

Reflections on Liquidity and Exits

  • Liquidity events such as IPOs or secondary sales can be challenging to time correctly, and decisions are often influenced by market conditions.
  • Investors may regret selling too early or not selling when they had the chance, but focusing on company growth and intrinsic value is key.

"Thank God. Yeah."

Eric Paley and Mike Maples discuss how sometimes being unable to sell shares due to illiquidity has inadvertently led to better outcomes as companies continued to grow in value.

Venture Fund Performance and LP Perspectives

  • There is a potential disconnect between the paper value of investments (TVPI) and actual distributions to LPs (DPI).
  • LPs may have varying preferences regarding liquidity events and distributions, but they generally seek outlier funds with exceptional returns.

"Those are great windows for selling companies."

Mike Maples acknowledges that certain market conditions provide optimal opportunities for selling companies, but also notes the potential long-term detrimental effects of inflated IPO valuations.

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