20VC Why VC Subsidizes the Wrong Type of Business, Why Capital Gains Tax is Crazy, The Biggest Misalignments Between VCs, Founders and LPs, Why Business Model Product Fit is as Important as ProductMarketFit with Chris Paik @ Pace Capital

In a candid conversation on "20 VC" with host Harry Stebbings, Chris Paik, General Partner at Pace Capital, delves into the nuances of venture capital, the evolution of direct-to-consumer brands, and the intricacies of building a venture firm. Paik reflects on his accidental entry into the venture world, his time at Thrive Capital, and the founding principles behind Pace Capital, emphasizing the importance of intentional investment pace and fostering an equal partnership structure. He challenges the traditional venture model, advocating for fewer, deeper relationships with portfolio companies and questioning the sustainability of venture-backed direct-to-consumer brands. Paik also discusses the misalignment of incentives between founders and investors, particularly in acquisition scenarios, and the potential for regulatory changes to address systemic issues in the venture industry.

• Most direct-to-consumer (DTC) brands are not suitable for venture capital investments.
• Venture capital often subsidizes businesses that should not have been VC targets.
• The role of venture capital is questioned in terms of its appropriateness for certain types of businesses.

"The vast majority of direct to consumer brands not suitable venture investments. Venture capital subsidizes business building of companies that should never have been venture capital targets."

This quote emphasizes the mismatch between many DTC brands and the venture capital model, suggesting that VC often funds businesses that are not aligned with the high-growth expectations typical of VC investments.

• Chris Paik co-founded Pace Capital, an early-stage venture firm in New York, after an eight-year tenure at Thrive Capital.
• Pace Capital's first fund was $150 million, followed by a second fund of $250 million.
• Chris's entry into venture capital was somewhat accidental, and he was initially skeptical of finance as a whole.

"And before cofounding Pace, Chris was a general partner at Thrive Capital, where he spent an incredible eight years, having joined the firm when they were on their first fund at $10 million."

This quote provides background on Chris Paik's experience in the venture capital industry and his progression from Thrive Capital to founding Pace Capital.

• Thrive Capital is recognized for leaning into the potential of people, regardless of age or credentials.
• Junior investors in venture often struggle for the opportunity to lead deals and prove their investment capabilities.
• Chris values the approach of giving young, ambitious individuals significant responsibilities early on.

"One of the things that thrive does really well, in my opinion, maybe even better than anyone else in the industry, is it leans into people's potential, regardless of their age, regardless of their credentials."

This quote highlights Thrive Capital's practice of empowering individuals based on potential rather than traditional qualifications, which Chris Paik admires and sees as effective.

• "Pace" suggests an intentional rate of resource expenditure to achieve a goal, rather than mere speed.
• The term resonates with the role of a venture investor as a pacemaker, supporting founders without running the race for them.

"Pace is not necessarily a fetishization of speed. It is a very intentional rate of resource expenditure to achieve a distinct goal."

This quote explains the philosophy behind the name "Pace," emphasizing strategic resource allocation and intentional growth rather than simply moving quickly.

• Pace Capital operates as an equal partnership to incentivize ownership behavior and attract top talent.
• The equal partnership model is seen as a powerful tool for both recruiting before individuals achieve widespread recognition and retaining talent.

"What better way to actually make people feel like owners than actually make them owners and make them equal?"

The quote captures the rationale for Pace Capital's equal partnership structure, which is designed to motivate partners by giving them a true sense of ownership.

• Pace Capital does not subscribe to the model of providing portfolio-added support services.
• The firm believes in a hands-on approach, committing fully to each company invested in rather than scaling the investor's capacity through additional services.

"You can't pay someone else to go to your kids soccer games for you."

This metaphor underlines Pace Capital's philosophy of personal commitment to their investments, contrasting with the practice of outsourcing support services in the venture industry.

• Pace Capital follows a concentrated approach, aiming for high teens to low twenties in terms of the number of companies in a portfolio.
• The firm targets 20% ownership in the companies they invest in, though they acknowledge exceptions based on high conviction.

"We target 20% ownership when we invest in a company."

This quote outlines Pace Capital's target ownership stake in their investments, which is part of their concentrated portfolio strategy.

• Pace Capital plans to scale by growing the firm and adding partners, avoiding titles like "co-founder" to empower future partners.
• The firm takes a patient approach to investment, with a longer investment period that helps manage bandwidth constraints.

"The short answer is yes. The longer answer is Jordan and I don't view ourselves as the only investors at pace."

This response to the question of scalability indicates that Pace Capital intends to expand its team to maintain a high-touch investment model as the firm grows.

• Chris Paik suggests investing in companies that cannot be described in a single sentence, arguing for the value of complexity and ambition.
• He distinguishes between consumer marketing, which requires simplicity, and the essence of a company, which may be multifaceted.

"Invest in companies that cannot be described in a single sentence."

This quote challenges the conventional wisdom of simplicity in investment pitches, advocating for the potential of more complex and ambitious companies.## Airbnb and the Sharing Economy

• Chris Paik discusses the difficulty of describing innovative companies like Airbnb in their early stages.
• He emphasizes that while Airbnb is now synonymous with the sharing economy, explaining its impact on real estate and economic return on homeownership was not straightforward at the beginning.
• Pithy descriptions may limit the imaginative scope of founders.

"Airbnb is easy to describe in a single sentence. Retroactively, they pioneer the sharing economy."

This quote highlights how Airbnb's business model has become a clear example of the sharing economy, but this clarity is a retroactive understanding.

"But if you were to describe Airbnb in the beginning and tried to explain how it affects real estate prices in markets because it changes the calculus of economic return on homeownership, that would be impossible to describe in a single sentence."

This quote emphasizes the complexity of Airbnb's early impact on the real estate market, which was not easily conveyed in a simple description.

• Chris Paik defines atomic value swaps as the essential value exchange between a company or product and the consumer.
• He illustrates this concept with a convenience store candy bar example, highlighting the simplicity of the sustainable value exchange.
• Paik extends this concept to online interactions, discussing the challenge of pricing intangible services like online dating.
• He contrasts platforms like Twitter, which offer distribution without economic reward, with YouTube, which compensates content creators economically.

"That atomic value swap is you are exchanging a dollar for a candy bar, which is presumably giving you $1 or more of value."

This quote explains the basic concept of an atomic value swap, using a simple transaction as an example to illustrate the idea of fair value exchange.

"Most marketplaces actually perfectly price the value that they deliver."

This quote suggests that many marketplaces are successful in aligning the price of their services with the value perceived by consumers.

• Chris Paik discusses the subjective nature of value, using Instacart as an example of how value differs for individuals based on their circumstances.
• He explains that platforms like Instacart and DoorDash price discriminate based on the consumer's valuation of their own leisure time.
• Paik touches on the difference between utilitarian purchases and the value of time, suggesting that consumers are willing to pay more for convenience.

"Instacart isn't a marketplace. The genius behind Instacart and DoorDash and other companies like that is that they perfectly price discriminate laziness and the value of a leisure hour."

This quote describes how companies like Instacart and DoorDash capitalize on consumers' willingness to pay for convenience, effectively pricing the value of time.

• Chris Paik introduces the seven deadly sins as timeless core motivators for human behavior.
• He argues that all individual behaviors can be distilled into one or more of these sins, suggesting that even altruistic actions serve self-motivation.
• Paik links self-motivation to consumer behavior, indicating that understanding these motivators can inform consumer investing strategies.

"The seven deadly sins are pride, envy, lust, gluttony, greed, sloth and wrath. These have not changed over millennia."

This quote lists the seven deadly sins, which Paik believes are fundamental motivators that have stood the test of time.

"I actually think the seven deadly sins are really core motivators."

This quote underscores Paik's belief that the seven deadly sins are the primary reasons behind why people do things.

• Chris Paik discusses the inverse relationship between the perceived virtuousness of a company and its enterprise value.
• He suggests that companies that focus on virtue may be good for marketing but may not translate into enterprise value creation.
• Paik differentiates between non-profits, which are not designed to create enterprise value, and for-profit companies, where virtue may not be central to the business model.

"I think that the virtuousness of a company is inversely related to its enterprise value."

This quote presents Paik's contentious view that companies focused on virtue may not create as much enterprise value as those that do not prioritize virtuousness.

• Chris Paik applies the seven deadly sins to Twitch, identifying both content creation and consumption motivations.
• He explains that Twitch incentivizes content creation with distribution and economic return, competing for user attention in the entertainment space.

"On the consumption side, it's entertainment. It's like some form of sloth and envy and pride. On the content creation side, it's some form of pride and greed."

This quote categorizes the motivations behind Twitch users' behavior, both for content creators and consumers, using the seven deadly sins framework.

• Chris Paik likens startup success to surfing a wave, emphasizing the importance of being in the water when the wave comes.
• He acknowledges that timing is critical and that while great founders can navigate and surf waves well, they cannot create them.
• Paik discusses the balance between being too early or too late to market and the role of market timing in venture success.

"The best analogy I can come up with for success in startups is you're surfing a wave, and half the battle is making sure you're in the water when the wave comes."

This quote uses the surfing analogy to illustrate the importance of timing and positioning for startup success.

• Chris Paik expresses agreement with the view that the market is a more crucial factor than the founder in determining a company's success.
• He references Warren Buffett's preference for businesses that can run effectively regardless of who is in charge, highlighting the importance of market demand and structural conditions.

"I think I probably tend to agree with you. Markets are a huge input into outcomes, particularly in venture."

This quote reflects Paik's belief that the market plays a significant role in the success of a venture, potentially more so than the founder.

• Chris Paik agrees with the notion that being too early is as detrimental as being too late.
• He stresses the need to be just one step ahead, not multiple steps, to succeed in the market.

"Being too early is just as bad as being too late in many ways."

This quote acknowledges the risks associated with incorrect market timing, comparing it to the game of rock, paper, scissors where only a slight lead is beneficial.## Venture Capital Suitability

• Venture capital is not suited for all types of businesses, especially those without market risk.
• Market risk is essential for a venture investment to be considered appropriate.
• There is a distinction between creating value and being a suitable venture investment.
• Venture capital is often conflated with the ability to create value, but they are not synonymous.

"Any company that is pure execution risk without any market risk is not a suitable venture investment."

This quote highlights the idea that venture capital is best suited for companies that face both execution and market risk, not just execution risk alone. Venture capital is about investing in businesses that have the potential to disrupt markets or create new ones, which inherently involves market risk.

• Tesla is used as an example to argue that even seemingly low market risk ventures have inherent market risks.
• The success of Tesla depended on factors such as pricing and infrastructure, which were not guaranteed.
• Market risk is about whether there is a validated demand for the product being introduced.

"I would say there was tremendous market risk creating Tesla. It was impossible to say that there would be millions, tens, hundreds of millions, billions of dollars of demand from consumers for electric vehicles."

Chris Paik contests the idea that Tesla had no market risk, explaining that the demand for electric vehicles was not structurally validated when Tesla started, representing significant market risk.

• Market sizing risk is about understanding the potential demand for a product.
• Execution risk refers to the ability to deliver a product or service effectively.
• Venture capital is not suited for businesses with well-understood demand and no significant market risk, like making polo shirts.

"The demand for polo shirts is well understood. I could start a business also creating polo shirts that would not be suitable for venture."

Chris Paik explains that ventures with well-understood and established demand, such as polo shirts, lack the market risk that makes them suitable for venture capital investment.

• Not all companies that create value are suitable for venture capital investment.
• The suitability of a company for venture capital is not solely based on the product but can also involve the go-to-market strategy and brand.
• Venture capital is often mistakenly seen as the only way to create value, which is not the case.

"There are plenty of companies out there that can create value, can create a lot of value that aren't suitable as venture investments."

Chris Paik emphasizes that while many companies can create significant value, they may not be appropriate for venture capital due to a lack of market risk or other factors.

• Venture capital should be existential to the existence of a company for it to be the right financing model.
• There is a distinction between companies that need venture capital to exist and those that can grow through other means like debt financing.
• The venture capital industry is not responsible for all forms of entrepreneurship.

"If the company literally could not exist without venture capital, that's probably a good criteria to suggest that it is within the realm of venture capital."

Chris Paik suggests that a key criterion for a company to be suitable for venture capital is if it could not exist or reach its potential without such investment.

• Defensibility is the ability of a company to maintain competitive advantages over time.
• The potential for defensibility can be present from day one in a company's design.
• Deliberate strategies and decisions lead to the creation of moats, not accidental occurrences.

"I think the recipe for defensibility can be very present on day one."

Chris Paik argues that defensibility is often embedded in the core product or business model from the inception of the company, indicating that it is not something that happens by chance but through intentional design.

• Venture capital can sometimes encourage entrepreneurship in areas not best suited for it.
• The industry benefits from a high volume of entrepreneurial attempts but this can lead to inefficiencies.
• There is a potential for improving the guidance of entrepreneurship to increase returns and reduce wasted efforts.

"Venture heavily incentivizes everyone to try everything all the time, and it's good for venture."

Chris Paik acknowledges that while venture capital encourages widespread entrepreneurial efforts, not all these efforts are suitable or efficient, suggesting that a more strategic approach could benefit the industry and entrepreneurs.

• The venture capital industry has misalignments in incentives between general partners (GPs), limited partners (LPs), and entrepreneurs.
• The current compensation structures in venture capital may not be optimal for the industry or society.
• There is a discussion about whether carried interest should be taxed as income to address these misalignments.

"It has to be regulation, right? It has to be regulation. Regulation is probably the only answer for one."

Chris Paik discusses the structural issues in the venture capital industry, suggesting that regulation might be necessary to address incentive misalignments and taxation issues related to carried interest.

• Fundraising as an emerging manager in venture capital is challenging and dependent on one's track record and reputation.
• LPs conduct thorough due diligence and reference checks that cannot be influenced by the emerging manager.
• Perception management is a key strategy when dealing with potential negative feedback during fundraising.

"For better, for worse, when you go out to raise money as an emerging manager, there's nothing you can do."

Chris Paik reflects on the fundraising process for emerging managers, acknowledging the limitations and the importance of reputation and past performance.## Investor Alignment vs. Fundraising Goals

• The goal of fundraising should be to find aligned investors rather than just hitting a target number.
• Aligned investors should have high fidelity of data to make informed decisions.
• The perception of data by investors can still be influenced even with alignment.
• Presenting data to investors should be done with self-awareness, not as a manipulation.

"Is the goal to hit a number or is the goal to find aligned investors? Because if the goal is to find aligned investors, you actually want your investors to have as high fidelity of data as possible."

This quote emphasizes the importance of transparency and alignment with investors over merely reaching a financial target. It suggests that the quality of the investor relationship is more important than the quantity of funds raised.

"Yes, but wouldn't you strictly prefer an investor that saw that as a feature, not a bug?"

Chris Paik suggests that the most desirable investors are those who view transparency and potential issues as positive attributes, rather than problems.

• Fundraising should focus on alignment with long-term goals and strategies.
• Relationships with Limited Partners (LPs) are meant to span decades, not just a few years.
• Transparency with investors about the future vision is crucial for long-term alignment.

"Our goal is for future GPs of Pace to have as good of relationships with the investment professionals that are LPs as we do decades in the future."

Chris Paik underscores the importance of establishing lasting relationships with LPs that extend beyond the immediate fundraising cycle and into the future of the firm.

• LPs have a difficult job of investing based on judgment rather than tangible assets.
• Successful LP engagements often stem from long-standing relationships.
• The common reasons for LPs to decline investments include the challenge of projecting future performance from limited data.

"Lps have to invest behind judgment. They're trying to fit a curve to a single data point if it's the first time that they're meeting you, and that is an impossible task to ask somebody to do."

Chris Paik explains the difficulty LPs face in making investment decisions based on limited interactions with fund managers, emphasizing the complexity of their role.

• The decision to do a single or multiple fund closes can involve ego and signaling in the industry.
• The key is to focus on what helps achieve the fund's goals, rather than getting caught up in micro-optimizations.

"We did a single close for both funds. I recognize that there's some ego signaling involved in that."

Chris Paik acknowledges that the choice between single or multiple fund closes can be influenced by industry perceptions and personal ego.

• Management fees stacking over multiple funds may not have been the original intention.
• Long feedback loops in venture capital can lead to slow adjustments and outdated practices.
• Theoretical solutions like carry clawbacks across funds could align incentives but are not supported by the current market.

"It's not clear to me that management fees were really intended to stack over multiple closed-end funds at increasingly high denominations."

Chris Paik discusses the potential misalignment of interests caused by the stacking of management fees in the venture capital industry.

• Misalignments can occur during acquisitions when management incentives do not align with the interests of the cap table.
• Short-term incentives can lead to decisions that are not in the long-term interest of all stakeholders.

"One of the biggest areas of misalignment between founders and investors is probably management incentive in an acquisition."

Chris Paik identifies a significant misalignment issue in the venture capital ecosystem, where acquisition incentives for management may not benefit the investors who supported the company's growth.

• A good board member acts as a reflective mirror to founders rather than offering prescriptive advice.
• Investor decisions are best made without reliance on synthesized information from associates.
• Personal involvement in due diligence leads to better investment decisions.

"I think a great board is meant to be a mirror to the founders."

Chris Paik shares his perspective on the role of a board member, emphasizing the importance of guiding rather than dictating the decisions of company leadership.

• Substack has product-market fit but may lack business model-product fit.
• Charging a percentage of revenue may not be sustainable at scale.
• Larger creators and platforms often negotiate lower rates, leading to margin compression.

"Substack is an interesting company where I don't know if they have business model product fit."

Chris Paik expresses skepticism about Substack's long-term business model viability, questioning whether their revenue-based charging model is sustainable as the company scales.

• The vision for Pace is to have a small, focused team of partners.
• The goal is for the firm to continue its focus on venture capital Series A and formative companies.

"Pace is five or six perfectly cool partners. I am no longer there."

Chris Paik outlines his long-term vision for Pace, indicating a desire for the firm to maintain a focused and effective team even after his departure.