In a dynamic conversation on "The Memo" with host Harry Stebbings, Jason Lemkin, founder of SaaStr, dissects the current state of the venture market. Lemkin predicts a resurgence of IPOs in late 2024, despite the current challenges in Series A and B funding, where investors seek discipline and founders hold high expectations. He also expresses skepticism about the work ethic of the current generation of tech workers, suggesting a preference for hiring individuals with adversity experience. Additionally, Lemkin discusses the strategic fundraising shifts among LPs, the role of sovereign wealth funds in sustaining mega venture funds, and the prevalence of confirmatory due diligence in VC, which often overlooks potential fraud. The episode also highlights innovative AI-powered platforms like Sauna and contract management solutions like Ironclad, emphasizing their efficiency and transformative potential for businesses.
"Anyone that thinks seed isn't happening, they're out of their minds. I don't think seed investors can participate in hot startups anymore. The reason there's a huge slowdown at AMB is not because the money isn't there. Everyone that's good has a fund, but it'll be an IPO week in the back half of 24." "My word, what a show we have in store for you today. This is the memo with me, Harry Stebings. Now, the memo is the monthly show where we deep dive on a specific topic or company, and today it is the state of the markets themselves, from seed to IPO and M&A what is happening, what is not happening, and what can we expect?"
The quotes emphasize the ongoing activity in seed investing and the anticipation of a future uptick in IPOs, setting the stage for the discussion on market trends and expectations.
"Sana is an AI-powered learning and knowledge-sharing platform. Think of it like Chat GPT. For all your company's knowledge, Sauna integrates with all your company's apps in under five minutes and can search through every single file, doc, pull request, video, and more in under 100 milliseconds." "Ironclad is a platform that helps companies harness the power of contracts to drive better business outcomes."
These quotes describe the functionalities of Sana and Ironclad, highlighting the importance of AI in improving business processes and knowledge management.
"Don't worry about doing a deal your first year. This is what the traditional GPS tell you, because the last thing they want you to do is to meet with 28 pretty good companies and burn the fund." "I did five real unicorns in my 1st 13 months. I did pipe drive, which exited for like 1.25 billion. And then Algoe was my second. That's worth 2.5 billion. It will IPO next year. I did talk test, worth 10 billion. I did Parkland Greenhouse, which will IPO next year. They're at 200 million. And I did Sellsoft, which sold for two and a half billion of cash."
Lemkin's personal experience contradicts the traditional advice given to new venture capitalists, demonstrating that with the right network and brand, it's possible to make significant early investments that pay off.
"All you have to do is hunt and meet founders, right? I think that's underestimated in the industry." "And then I think just really sticking to your sweet spot is core right. And I knew I only wanted to do a certain type of founder at a certain stage doing products I intuitively understood."
These quotes reflect Lemkin's approach to venture investing, focusing on areas of personal expertise and leveraging the freedom to meet with founders without existing portfolio distractions.
"There's no downturn in seed whatsoever. No matter what. Twitter's wrong. Seed is more vibrant than ever, and we can talk about why." "Every week there's more liquid tech folks that want to invest in seed, either directly or creating funds."
Lemkin argues against the perception of a seed investing downturn, pointing out the continued enthusiasm and increased participation from successful tech individuals.
"What's 2% of the fund per check? And so for me, I learned there were two types of investments I wanted to make." "But I think the last thing you want to do is pass on a $30 million post deal where everything's great."
These quotes highlight Lemkin's pragmatic approach to investment, focusing on meeting ownership targets and not getting overly concerned with valuations, as long as the fundamentals of the deal are strong.## Venture Capital Math and Big Wins
"You need double digit ownerships of four to five massive $5 billion plus outcomes per year." This quote emphasizes the necessity for venture funds to have significant stakes in a few very successful companies to reach their financial goals.
"The math is just awesome." This quote reflects the potential high returns from investing in big winners and owning a substantial share of their equity.
"It's great if you can start in seed, but if it distracts you from putting 100 million into the winner, it's not worth the distraction." This quote suggests that while seed investments can be beneficial, they should not take away from the opportunity to invest larger sums in more certain winners.
"The big fund partners are saying I'm underwater with refinancings, with board positions, with company dojas, with rifts, principals and associates who haven't led rounds before. Go and write one to $2 million checks. Go and spray cash." This quote describes the pressures big funds face, leading them to distribute smaller investments across a broader range of companies, potentially diluting their focus and discipline.
"And that's leading to less and less price discipline at the seed, because you've got this whole new entrant of less." This quote highlights the consequence of big funds' strategies on the seed market, where the influx of capital from inexperienced investors is eroding price discipline.
"Most of the world is not privileged, Harry. Most of the world did not graduate from Stanford, or stripe, or Y combinator." This quote emphasizes the existence of talented entrepreneurs outside the traditional elite circles, suggesting they can offer better investment opportunities due to more reasonable valuations.
"Insiders are priced to perfection. But if we take a pause, shouldn't they be the venture markets have changed so much in my career." This quote reflects on the changing venture capital landscape, where insiders command high valuations, potentially making seed investing in these companies unviable for traditional seed funds.
"Seed then we have this increase in supply from operators, a temporary increase in supply, but still an increase in supply, no matter how temporary, from multi-stage funds." This quote indicates a surge in the number of players in the seed market, which affects the traditional seed investing approach.
"I don't think seed investors can participate in hot startups anymore." This quote suggests that seed investors may no longer be able to compete for the most sought-after startups due to inflated valuations and competition from larger funds.
"Keith, how do you do it? David, Sacha, Eileen, they all have done some of their best investments from cold inbound." This quote reveals that even successful venture capitalists can find valuable investment opportunities through unsolicited inbound pitches, although their preferences for the format of these pitches vary.
"No one in the world at Softbank or Tiger or even the better ones, the iconics, I can't imagine any of them respond to raw inbound emails." This quote indicates that at later stages of investment, such as with large growth funds, cold outreach is less likely to be successful compared to earlier stages.
"I don't agree at all. It's possible he's reacting to the 700 million dollar seed. I don't think seed investors can participate in hot startups anymore." This quote expresses disagreement with the idea that seed investing will return to its high-risk roots and acknowledges the challenge of participating in highly valued seed rounds.
"I just don't think you can make money in seed investing in hot seed startups." This quote underscores the difficulty of achieving returns from investing in popular seed-stage startups due to their high entry valuations.
"But maybe their job is not to invest in the perfect high profile, obvious, perfect seed fund, maybe." This quote suggests that seed funds may need to reconsider their investment strategies and focus on less obvious opportunities rather than chasing high-profile startups.
"Go find Jody before his first one, not his second one." This quote encourages seed investors to discover talented entrepreneurs early in their careers before they become well-known and command higher valuations.
"All of them. Now they all like different things." This quote highlights the diversity in preferences among VCs for evaluating inbound pitches, with some favoring concise communications and others wanting more detailed information.
"But it was one of them, right?" This quote implies that even among a multitude of inbound pitches, there can be valuable investment opportunities that lead to successful outcomes.
"Categories get reinvented, right? They get reinvented every four to five years." This quote acknowledges the cyclical nature of innovation within startup categories and the need for investors to adapt to these cycles.
"The more crowded a category, the later I would invest." This quote reflects a strategic approach to investing in crowded markets by waiting to see which companies emerge as leaders before committing capital.
"We are bouncing off the bottom. We are bouncing off these lows." This quote suggests that the trend of cutting back on software spend and bundling is reversing, with companies beginning to increase their investment in innovative solutions.
"We have bounced off the bottom how high we're going to bounce." This quote indicates optimism for the future of software purchasing, with expectations for a rebound in spending and innovation.
"I think it's terrible." This quote bluntly assesses the current state of the Series A and B markets, highlighting the difficulties faced by both investors and founders.
"A and B's want a return to rationality, and founders aren't there yet." This quote identifies the gap between investors' desire for reasonable valuations and founders' expectations for their funding rounds.
"There should be a massive wave of startups with twelve months of Runway and no traction, but not a decade of that was a zerp phenomenon." This quote critiques the recent trend of startups receiving extensive funding without demonstrating significant progress, attributing it to a unique economic environment.
"Founders today don't respect venture capital anymore. And it's one of my least favorite parts of the industry." This quote expresses concern about the changing relationship between founders and venture capitalists, with a perceived lack of respect from founders towards the venture capital industry.## Venture Capital's Shift in Perception
"In my day, venture capital was so hard to get. We over respected it."
This quote reflects the past reverence for venture capital, contrasting with the present scenario where founders often undervalue it.
"It's just this disconnect for what anything means, what an exit means, how hard it is."
Jason Lemkin highlights the lack of understanding among some founders regarding the significance of fundraising, exits, and the responsibility towards investors.
"But for where you're at today, I can't do it for a variety of reasons."
Jason Lemkin explains his decision not to invest in a founder with unrealistic valuation expectations, emphasizing the importance of aligning investment with company progress.
"You got to have some hoodspa sometimes to be a founder."
Despite recognizing the need for confidence among founders, Jason Lemkin points out the issue with founders not understanding the gravity of investment and exits.
"Does your fund strategy in size and risk profile permit you to pay two x to derisk that investment?"
Jason Lemkin questions whether an investment fund's strategy aligns with paying higher valuations for experienced founders to reduce risk.
"I feel like I can help mitigate that risk by working with them."
Jason Lemkin expresses confidence in his ability to support first-time founders, thereby justifying investments in them despite their lack of experience.
"If you're a true outsider, if you just showed up in the Bay Area from Lisbon or even London or Estonia or Paris, and know nobody, you didn't even get to go through YC, you know nobody."
Jason Lemkin acknowledges the challenges faced by founders who are new to a startup ecosystem and how investors can play a crucial role in their success.
"It's outsiders versus insiders. If you have to help insiders, it's embarrassing."
Jason Lemkin contrasts the support needed by outsiders to the expectations of self-sufficiency from more established founders within the ecosystem.
"It's because that's what it takes to sustain a team."
Jason Lemkin explains that the growth of a fund is often necessary to support a larger team, not just for the sake of increasing management fees.
"I consider myself a founder first and an investor second, and I just couldn't do it."
Jason Lemkin reflects on his personal preference for staying true to his identity as a founder rather than becoming a large fund manager.
"Series A is the best place to invest today in cloud and SaaS."
Jason Lemkin identifies Series A as an attractive investment stage due to market dislocations that create opportunities.
"Every round is supposed to be harder, but in 2021, every round got easier."
Jason Lemkin comments on the abnormal ease of fundraising in 2021, contrasting with the traditional expectation of increasing difficulty in each funding round.
"Every VC diligence call is like that, right. And then there are certain spaces where I know something about."
Jason Lemkin shares his frustration with the superficial nature of due diligence calls in venture capital, where his expert advice is often disregarded.
"The truth is, they only do confirmatory due diligence."
Jason Lemkin criticizes the venture capital industry for conducting due diligence that seeks to confirm pre-existing biases rather than rigorously evaluate potential investments.
"Everyone's got a founder that claimed they had ARR, that really mashed months together, that their financials were not accurate, that misrepresented a plan that was impossible."
Jason Lemkin points out the commonality of fraudulent behavior among founders in the startup ecosystem.
"My NPS has been damaged from it. I've had multiple times when the company was going to drive the car off the cliff, I had to have the talk, and it saved the company."
Jason Lemkin acknowledges the impact on his reputation from taking a stand against fraudulent or misguided founders, indicating the personal cost of such interventions.
"For traditional cloud companies, SaaS companies, at growth, I would say, generally speaking, there's a 15 x ARR ceiling."
Jason Lemkin outlines the current valuation ceiling for growth-stage investments in the cloud and SaaS sector.
"Today, 15 x is not a bad deal. The public averages six x."
Jason Lemkin contextualizes the 15x ARR valuation for growth-stage companies as reasonable compared to public market averages.## SaaS Company Growth and Investment
"Harry, you and I are running the SaaS company, we're at 40 million ARR. We're kind of breaky even and nice guy. Growth fund wants to buy 20%, but then we have to do more and we have to report to them." "Let's do it at 60. Let's wait till we're next year. It's feeling pretty good. Harry, why don't we do it at 60 or 70? Like, this seems like a stressful time to do it at 40 or 30."
The quotes discuss the strategic decision-making process regarding when to accept investment and the potential downsides, such as increased obligations and stress.
"If I can't get 15 x deal from the company, I'm going to try to get it from the seed guys." "The companies I have that are efficient north of 30, they're overwhelmed with folks often not to me, although sometimes to me, but from anyone else trying to clean up the cap table at the valuation they want."
The quotes highlight the strategies of growth investors to secure deals with early investors and the overwhelming interest in secondary markets for successful SaaS companies.
"The best lps want. Best lps want these six x eight x ten x funds. They really do. And they're more appreciative of how rare they are than we all thought it was." "I recently had a conversation with one of my lps last week about a secondary offer that was, whatever, ten figures. A ten figure secondary offer. Okay. And we both agreed no was the answer."
The quotes reveal insights into the perspectives of LPs on liquidity and returns, and the decision-making process regarding secondary offers.
"My three largest lps, okay, who Again, I all met with, and they all said don't take the secondary, the billion dollar plus secondary." "One said, which is a wildly successful university endowment for their category. Number one. Okay, they're dropping two managers this year. Good managers."
These quotes discuss the strategic decisions made by LPs, such as not taking secondary offers and dropping managers, to focus on a concentrated portfolio of high-performers.
"It's never been so hard to fundraise since the.com boom." "I think it's very dependent on lp type. You have certain lp types, foundations, endowments that have annual payments for, scholarships for." "I actually had lunch with one of the kind of biggest fundraisers gps in the world who raises billions a year."
These quotes discuss the current fundraising climate for venture capital funds, the challenges faced, and the differing needs of LP types.
"It'll be huge in the back half of 24. It'll be huge." "I think it'll be a good IPO a week, at least a good one that we've heard of in the back half of 2024."
These quotes offer a prediction on the opening of the IPO market, suggesting a significant increase in activity in the latter half of 2024.
"I just don't think most of the current generation of folks will ever work hard again." "Everyone has a side hustle. Everyone's working 20 hours a week." "This is where I sound like a fuddy duddy, but this is what's broken in venture."
These quotes reflect Lemkin's perspective on the challenges of hiring in the tech industry and the perceived decline in work ethic among the current generation of workers.
"I kind of admire the tiger strategy. Massive momentum investing." "Softbank? I don't know. Those things are going to die. And then when multiples get insane again, they'll all reappear."
The quotes discuss the investment strategies of Tiger and Softbank, highlighting the cyclical nature of their success and challenges.