Podcast Summary
Changes in the VC market: Size, transparency, and LP concerns: Despite larger fund sizes, LPs demand transparency and realistic valuations, leading to a 'flight to quality.' Smaller funds may still outperform due to agility and flexibility.
The venture capital market is undergoing significant changes, with funds growing in size but facing challenges in raising capital due to LP concerns over inflated valuations from the past market. Anonymity in crypto companies was brought up as an example of the importance of transparency, which becomes crucial for VCs in evaluating investments. The current market is characterized by a "flight to quality," with LPs seeking to invest in funds with solid track records and realistic valuations. The discussion also touched upon the decrease in the total amount raised by venture funds and the increase in median time for fund closures. Overall, the panelists agreed that smaller funds may still outperform larger ones due to their ability to be more agile and flexible in their investment strategies.
LPs cautious in investment decisions due to market downturn: LPs are reducing venture capital investments, focusing on portfolio preservation, and dealing with financial instability, leading to a hesitancy to invest in new funds.
Limited Partners (LPs) in the venture capital industry are more cautious in their investment decisions due to the market downturn. They are focusing on preserving their portfolios by reducing the percentage of venture capital investments and waiting for returns. Many LPs are also dealing with their own financial instability, leading to a hesitancy to invest in new funds. Jason shared that during his fundraising process for Launch Fund 4, he encountered a large number of LPs who were not investing in 2023 or 2024 and were focusing on exiting current investments. Additionally, some LPs were considering leaving their current positions due to job instability. Despite the challenges, Jason remains optimistic and expects the cycle to start anew as the market recovers and interest rates decrease. His fundraising process is set to be completed by May 1st.
Opportunities for Emerging Fund Managers in 2024: Emerging fund managers can secure investments from family offices and angel investors despite challenging fundraising environment. Strong online presence, clear investment thesis, and building relationships with the right investors are key to success.
Despite the challenging fundraising environment in 2024, there are opportunities for emerging fund managers to secure investments, particularly from family offices and angel investors. The importance of having a strong online presence, such as a professional website, cannot be overstated. Smaller funds have historically outperformed larger ones, with smaller funds from 1969 to 2015 having a 20% IRR compared to 7.2% for funds sized between $400 million and $1 billion, and 2.4% for funds over $1 billion. Zach attributes this to the ease of deploying smaller amounts of capital and the potential for experienced VCs to raise larger funds than they can effectively manage, leading to increased competition and potentially subpar performance. Emerging fund managers should focus on building relationships with the right investors and having a clear, differentiated investment thesis. Additionally, having a professional online presence is crucial in today's digital age.
The competition for deals increases as VC firms grow, leading to higher valuations and reduced returns.: As VC firms grow larger, they face increased competition for deals, requiring larger check sizes and more resources, resulting in fewer investments and reduced returns.
As a venture capital (VC) firm grows and becomes more successful, the competition for deals increases, driving up valuations and reducing returns. This is because larger funds require larger check sizes, making it difficult for a single person to deploy capital efficiently. The shift from qualitative to quantitative metrics in well-known companies also attracts more competition. For instance, a $100 million fund can deploy around $20 million annually, but a $1 billion fund would need to write checks 50 times larger. This not only requires more resources but also puts VCs in competition with larger institutions. The portfolio construction of a VC firm also changes as companies become more established and valuable, making it necessary to invest larger amounts in fewer companies. For instance, a billion-dollar fund might aim to put 30 names into the portfolio, which would require investing around $30 million per company. Given the limited number of deals that can be done, this is not feasible for a traditional VC firm. Instead, programs like Y Combinator, 500 Startups, Techstars, and Foundry University aim to invest in a larger number of companies to increase the chances of identifying unicorns early in their life cycle.
Investing in multiple early-stage companies: VCs invest in numerous early-stage firms for potential high returns, despite most not yielding significant gains. Smaller funds have an edge due to earlier investment opportunities and fewer competitors.
Successful venture capitalists prioritize investing in a large number of early-stage companies with smaller checks and later focusing on a smaller number of those companies with larger investments as they grow. This approach allows for potential high returns, even if most investments do not result in significant gains. Smaller funds have an advantage in this regard as they can invest earlier and still make strong multiples, while larger funds face more competition and fewer opportunities for high returns at later stages. However, it's essential to maintain a high standard of investment quality to ensure consistent performance as the fund scales up.
Maintaining a disciplined investment strategy is crucial for an accelerator's success: Focus on investing in a manageable number of high-quality startups to avoid the 'accelerator doom loop' and look for strong technical founding teams.
Maintaining a disciplined investment strategy is crucial for the success of an accelerator program. Investing in too many companies without ensuring quality can lead to a downward spiral, known as the "accelerator doom loop." This happens when the number of applicants increases, acceptance rates drop, and the quality of companies begins to degrade. To avoid this, it's essential to be a curator of companies, focusing on investing in a manageable number of high-quality startups. Y Combinator, for instance, accepts about 1% of applicants and invests in around 200 companies per year. By increasing the number of applications while keeping the number of investments steady, the quality of the portfolio can be maintained. Additionally, looking for founding teams with a strong technical background is another way to ensure the success of the investments.
Maintaining a low acceptance rate for high quality deals: With a large applicant pool, being selective and efficient in the evaluation process is crucial for successful investing.
When it comes to investing in startups, having a large pool of applicants can allow for greater selectivity. According to the speakers, with thousands of applications a month and only a hundred investments a year, maintaining an acceptance rate below 1% is a rough guideline for ensuring a high quality of deals. Personal networks and referrals can significantly reduce the number of deals to review and increase the likelihood of investing in successful ventures. When evaluating new introductions, investors look for novelty, expertise in relevant industries, and unique insights from the founders. Automated rejections and templated responses are also used to quickly filter out a significant portion of applicants. Overall, the key takeaway is that with a large number of applicants, being selective and efficient in the evaluation process is crucial for successful investing.
Identifying Unique Ideas with Clear Differentiation is Key for Startups: Investors prioritize unique ideas with clear differentiation to increase chances of success and reduce competition, as not all startups will become unicorns, and the Bay Area dominates the startup scene but location is secondary to idea and team quality.
Differentiation is crucial for startups, especially in crowded markets. Investors prefer unique ideas with clear differentiation, as it increases the chances of success and reduces competition for customers and funding. Adjacent businesses to established companies may not be enough to create an outlier, as they often face the challenge of competing against larger players with significant resources. The odds of a startup becoming a unicorn are low, with estimates suggesting that only one in 2000 startups reach this status. Therefore, investors need to be skilled at identifying and investing in the handful of unicorns that emerge each year. The Bay Area continues to dominate the startup scene, raising significantly more funding than other major markets in 2023. Despite this, the location of an investor or founder is less important than the quality of the idea and team.
The Bay Area's importance for startups: The Bay Area's density and access to investors, talent, and resources make it a top location for building and scaling world-class companies. In-person interactions are crucial for securing funding and building relationships.
The Bay Area, despite its challenges, remains a hub for world-class companies and founders due to its density and access to investors. In-person meetings are valued highly in securing funding, and the trend is for founders and investors to return to the area as restrictions ease. Hustle Fund, which invests globally, acknowledges the importance of the Bay Area but also recognizes that not all companies need to be based there to solve their specific problems. In-person interactions are crucial for building relationships and understanding the seriousness of founders, leading to a higher likelihood of funding. The Bay Area's density and access to talent and resources make it an unparalleled location for building and scaling world-class companies.
The Bay Area is no longer a requirement for building a successful startup: 21% of remote pre-accelerator teams are based in the Bay Area, demonstrating the efficiency and effectiveness of remote collaboration, making it possible to build successful startups from other locations.
The San Francisco Bay Area is a hub for innovation and high-growth companies, offering unique advantages for founders, such as access to a dense network of knowledgeable peers and experienced talent. However, with the rise of remote work, it's becoming increasingly possible to build successful companies from other locations. The numbers speak for themselves, with over 21% of teams in a specific pre-accelerator program already being based in the Bay Area, despite the program being designed for remote participation. People are forming companies and even meeting co-founders for the first time remotely, demonstrating the efficiency and effectiveness of remote collaboration. While the Bay Area remains a desirable location, it's no longer a requirement for building a successful startup.
Finding the Right Team in the Crypto Industry with LinkedIn: LinkedIn is a valuable resource for small businesses to find and connect with potential team members in the crypto industry, despite the challenges of anonymity and investor scrutiny.
Building a successful company requires a great team, but finding and hiring that team can be challenging, especially in the crypto industry where anonymity is common. This can lead to issues when investors want to know the identities of the team members. A solution for small businesses with limited resources and time for hiring is to use LinkedIn, which has over 1 billion users and can help connect businesses with both active and passive job seekers. However, the trend of unicorn companies, which have seen a significant increase in number but a decrease in liquidity, may make it difficult for venture capitalists to return capital to Limited Partners (LPs). This could lead to an increase in secondary markets or other creative solutions for LPs to recoup their investments.
Determining Billion-Dollar Potential in Emerging Companies: Smaller venture capital funds face unique challenges, but optimism remains for disruptive innovation and entrepreneurial resilience to yield billion-dollar companies
The current market is undergoing a significant process of determining which emerging companies have the potential to become billion-dollar entities. Those who are not progressing as expected may face shutdowns or mergers. The venture capital industry is characterized by varying incentives, with some funds enjoying large returns and lavish salaries due to their size and the paper markups they generate. However, smaller funds, like the ones discussed, have to live off the carried interest, which significantly alters the behavior and incentives of those involved. The trend of declining capital efficiency in enterprise companies has been observed over the past decade, and despite the challenges, there's optimism that many great companies will emerge from the "zerp" (zero to one) area due to the potential for disruptive innovation and the resilience of entrepreneurs.
Capital-efficient businesses in a resourceful era: During economic downturns, founders can focus on building capital-efficient businesses, which will be more resilient and profitable in the long run. Understanding capital efficiency is crucial to navigating this environment effectively.
The current economic climate may not be ideal for raising large amounts of capital, but it presents an opportunity for founders to focus on building capital-efficient businesses. The speaker, who has experience starting a company during a previous economic downturn, believes that this era will foster a new wave of efficient and resilient startups. The lack of available capital and intense competition in the past led to unnecessary spending and a destructive cycle of low returns. However, the current situation is shifting towards a more capital-conscious environment, where companies will need to be resourceful and strategic to succeed. This period could lead to significant returns for those who are able to navigate it effectively. The speaker also emphasizes the importance of understanding capital efficiency, which is calculated by dividing a company's valuation by the amount of capital raised. This metric can provide insight into the financial health and sustainability of a business.
Decreased efficiency of raising capital and its impact on valuations: The intense competition among companies for funding has led to a decrease in the efficiency of raising capital and a corresponding decrease in valuations, particularly in the consumer and enterprise sectors. Building long-term relationships with founders and making informed investment decisions are crucial.
The efficiency of raising capital and the resulting valuations have drastically decreased, particularly in the consumer and enterprise sectors. This trend can be attributed to the intense competition among companies that have raised large amounts of funding, leading them to use capital as a weapon in a "race to the cliff." However, this strategy can be unhealthy and unsustainable. For instance, if a company raised a million dollars in 2023, its valuation would be around seven million dollars on average. In contrast, a decade ago, a million-dollar investment would have resulted in a valuation of 26-27 million dollars. This shift highlights the importance of making informed investment decisions and building long-term relationships with founders. During our portfolio check, Zach shared his excitement about three recent investments: Shovels.ai, which uses AI to parse government data sets, and Anadro, which helps landlords create utility companies for their tenants. These investments demonstrate the value of companies that leverage technology to address specific market needs and the importance of backing founders with a proven track record.
Innovation through technology and partnerships in various industries: Anadro uses solar paneling and software for energy optimization and Bitcoin mining, podcast AI saves time and resources, and EchoMark ensures document security with invisible watermarks
Innovation is happening in various industries through the use of technology and partnerships. In the energy sector, Anadro is leveraging solar paneling and software for energy matching, optimizing energy usage, and even running Bitcoin miners to sell excess energy back to the grid. In the podcasting industry, podcast AI is revolutionizing post-production with transcript generation, chapter creation, and metadata generation, saving time and resources for podcasters. In the document security sector, EchoMark is implementing invisible watermarks on documents to ensure security and traceability, making it impossible for leaks to go unnoticed. These companies exemplify the power of technology and collaboration to solve complex problems and create value in their respective industries.
Innovative solutions for mental health and cooking education: Bruin Health targets mental health needs of internal medicine patients, Zest gamifies cooking education, and Bug Zero improves software performance through bug management.
Bruin Health and Zest represent innovative solutions in the mental health and cooking education spaces, respectively, that cater to specific needs and pain points of their target audiences. Bruin Health aims to help internal medicine physicians better address their patients' mental health needs, while Zest gamifies the learning process for individuals looking to cook for themselves and their families. Both companies have identified unique consumer motivations and have designed well-targeted products to meet those needs. Bug Zero, on the other hand, focuses on enterprise software, helping companies manage and prioritize bug reports and updates to improve their software performance. These companies stand out by addressing specific challenges in their industries and providing valuable solutions to their customers. As investors, we look for new and different approaches to existing problems, and these companies deliver just that.
Technology's Impact on Event Planning: After Work and River.io: After Work automates event planning tasks to save time and money, while River.io connects startups for local meetups and communities
Technology is revolutionizing event planning by streamlining the process and reducing costs. During a conversation, the speakers shared their experiences with two innovative companies, After Work and River.io, which are making a significant impact in this space. After Work is an event planning tool that helps users find and book venues, coordinate catering, AV equipment, and more, all in one place. By automating these tasks, After Work saves time and money for businesses and individuals planning events. The potential cost savings are substantial, with party planners typically costing thousands of dollars per event. Another company, River.io, is focusing on coordinating local events for startups and founders. By creating a platform for founders to connect and organize meetups in their cities, River.io is tapping into an untapped market and providing a valuable service. These meetups, while occurring naturally, have the potential to grow into larger events and communities when coordinated effectively. Both After Work and River.io demonstrate the power of technology to simplify event planning and create new opportunities for businesses and individuals alike.
Building and nurturing communities can lead to valuable connections and opportunities for founders: Founders can build and nurture communities around their personal interests to learn from each other, find solutions to common challenges, and create valuable connections and opportunities.
Building and nurturing communities can lead to valuable connections and opportunities for founders. This was highlighted in the discussion with Elizabeth Yen and Zach Colias, who shared their experiences with investing in companies and building communities around their personal interests. Brian Johnson, for instance, started a community around his "Don't Die" franchise, which grew from a simple running group to a large network of meetups in various cities. Founders can benefit greatly from coming together and sharing their experiences, as they can learn from each other and find solutions to common challenges. The creation of Founder Fridays, an event by founders for founders, is a testament to this idea and provides a platform for founders to connect, learn, and grow together.
Founder Fridays: Learning from Each Other: Founder Fridays offer founders the opportunity to connect, learn, and grow in an intimate setting. Hosted by founders, these non-commercial events provide a platform for sharing strategies, techniques, and tools to help businesses thrive.
Founder Fridays, hosted by This Week and Startups, provide a unique opportunity for founders to connect and learn from one another in an intimate setting. These non-commercial events, which are hosted by founders in various cities around the world, offer a chance to learn new strategies, techniques, and tools to help grow businesses. Unlike traditional conferences, these meetups are not about service providers selling software or passive speakers, but rather founders sharing their experiences and knowledge. To attend or host a Founder Friday, visit thisweekandstartups.com/meetups and sign up for a River account. These events are for founders only, and the first one will begin on February 2nd. With hosts and attendees already lined up in cities such as San Francisco, New York City, Toronto, and more, this is your chance to connect with the founder community in your area.
