Latest / The Learning Corner by Precursor / Episode #5: Euclid Insights, Strictly VC

Transcript

Episode #5: Euclid Insights, Strictly VC · The Learning Corner by Precursor

• 0:01
  I'm a big believer that no amount of ownership can fix bad selection.
• 0:04
  I would always rather be a 1% owner in a fantastic business than a 20% owner in a
• 0:08
  mediocre business.
• 0:09
  I would take that trade 100 times out of a 100.
• 0:11
  It's the week of October 21st.
• 0:13
  Welcome to The Learning Corner, a Precursor Ventures podcast.
• 0:21
  Welcome to the Learning Corner by Precursor.
• 0:24
  I'm Mia Farnham, and I'm joined by our GP and managing partner, Charles Hudson.
• 0:29
  And we will be talking through the articles and Goodreads that caught our team's attention over
• 0:34
  the past week.
• 0:35
  Topic number 1, the seed stage reckoning, another read by Euclid Insights.
• 0:41
  And the seed stage reckoning discusses the current state of seed stage investing,
• 0:45
  highlighting a shift in the market where founders and investors are facing even greater
• 0:50
  challenges.
• 0:50
  As it's become harder to graduate to subsequent rounds of funding, the essay cautions against
• 0:56
  investing across fast growing or hype centric markets, or case studies across Fintech,
• 1:00
  crypto, etcetera, that show it's incredibly difficult to foresee the end of the upcycle and
• 1:05
  inevitable underperformance in investments.
• 1:07
  They also walked through their strategy, investing in a small number of founders each
• 1:11
  year, and going all in to garner 10% equity ownership upon this first investment.
• 1:17
  So when an exit comes about, it's fun making.
• 1:19
  Charles, you got multiple shout outs throughout the article, referencing a previous blog post
• 1:23
  you wrote.
• 1:24
  The Euclid Insights team specifically applauded your one quote, dilution is our enemy too.
• 1:28
  We will make the majority of our financial returns from our first check and investment
• 1:33
  decisions.
• 1:34
  And while we can all agree on your quote, if you're a fund manager of truly any type, at
• 1:39
  Precursor, we actually have a different strategy than Euclid in that we write far more
• 1:42
  checks per year and our size can vary.
• 1:44
  So can you share a little bit more about that and how it still succeeds its reckoning age of
• 1:49
  seen stages?
• 1:50
  We'll write 30 to 40 new full size checks a year.
• 1:53
  So think, like, 80 to a 100 per fund.
• 1:55
  Much different portfolio construction than most venture funds.
• 1:58
  It works for us.
• 1:59
  We're generalists.
• 2:00
  We're investing pre product market fit, oftentimes pre launch.
• 2:03
  I think there's just a lot of ideas that I think are worth pursuing at that stage, and so
• 2:07
  it works for us.
• 2:08
  Also, our funds are pretty small.
• 2:10
  And over time, like, you could we've we're approaching 7 to 10% ownership on entry, but I
• 2:14
  think the smaller your fund, the less you need to own of great companies to make the math
• 2:19
  work.
• 2:19
  And I'm a big believer that no amount of ownership can fix bad selection.
• 2:22
  So I would always rather be a 1% owner in a fantastic business than a 20% owner in a
• 2:26
  mediocre business.
• 2:27
  I would take that trade 100 times out of a 100.
• 2:29
  And so I think our whole strategy is predicated on finding really awesome to be discovered,
• 2:34
  misunderstood, 0 to 1 companies investing at evaluation that is fair to us and fair to the
• 2:39
  founder and being right.
• 2:40
  And I think most people though are like, it's easier to find a small number of things every
• 2:45
  year where you think you're right and go big on those.
• 2:47
  And I actually really admire people whose brains are wired that way.
• 2:50
  Mine, mine just isn't that isn't the way I invest.
• 2:52
  That isn't the way I've been successful.
• 2:54
  And I keep coming back to a couple of things that to me just are fundamental about seed.
• 2:59
  I was telling my friend this over the weekend.
• 3:01
  Seed is mostly a long only business.
• 3:03
  You're gonna buy something and you're gonna hold it essentially until maturity or until
• 3:07
  somebody's willing to buy it from you, which means if you make a mistake, you're stuck with
• 3:11
  it.
• 3:12
  And this has always been, like, my one question about some other strategies is if I have a
• 3:17
  vertical specific fund and the tide goes out on my vertical, what do I do?
• 3:21
  Because I'm holding a basket of illiquid, long dated securities in a theme where there's,
• 3:26
  like, literally no demand.
• 3:27
  And if I think about our portfolio, because we're a generalist, we live through the wave
• 3:31
  of, like, nobody wanted to fund CPG anymore.
• 3:33
  Nobody wanted to fund consumer.
• 3:35
  Nobody wanted to fund consumer fintech.
• 3:37
  Nobody wanted to fund digital.
• 3:38
  Like, almost every sub sector we invest in has had I mean, we don't do crypto, but crypto
• 3:43
  obviously has its winters and summers.
• 3:44
  And I just have always been terrified as a fund manager of having a concentrated book of
• 3:49
  business, a category that's on that's, like, basically unfundable.
• 3:53
  That's why I think our strategy works well for me.
• 3:55
  The thing I keep thinking about is I told our team this.
• 3:58
  I've told everybody this.
• 3:59
  Graduation rates foresee are coming down.
• 4:02
  And also, I feel like the compression of hype cycles is real.
• 4:06
  Like, everything that's happening in AI to me feels like it's happening faster than what
• 4:10
  happened in crypto, which felt faster than mobile.
• 4:12
  The scary thing now is like people are putting a lot of money to work with a belief that they
• 4:17
  have a point of view on the future.
• 4:18
  And we just don't know if they're right yet.
• 4:20
  And the velocity of capital is high.
• 4:22
  And I think this is particularly problematic if your strategy is to try to pile into winners
• 4:27
  and you misidentify a winner.
• 4:29
  And so one nice thing about having light reserves is I can only do so much damage with
• 4:32
  reserves.
• 4:33
  The majority of our money is gonna be in 1st checks.
• 4:34
  And if there's a company that appears to be taking off, there's always so much we can pile
• 4:38
  into it, which, yes, if it's a super compounder and it's amazing, we will wish we had more
• 4:42
  money.
• 4:42
  But it's also a check for us on becoming too concentrated in a company that gives you an
• 4:47
  early false signal.
• 4:48
  In the days of crypto when it was in their summers, did you find yourself having
• 4:53
  conversations with LPs and then pushing back on you not wanting to move into that market?
• 4:56
  And do they mirror the kind of discussions you have now with LPs who are questioning you not
• 5:02
  wanting to rush into b two b AI.
• 5:04
  I think the conversations were similar but different in one important way.
• 5:08
  The crypto thing pretty quickly on is like, oh, there's a lot of money to be made here, but
• 5:13
  it's also liquid, and it's also tradable.
• 5:15
  So why do you need to pay me if you wanna hold coin?
• 5:18
  Unless there's some reason that your organization can't custody the crypto and you
• 5:22
  need me to buy it for you and hold it.
• 5:24
  If you wanna go buy $10,000,000 worth of Bitcoin, like, why should you do that through
• 5:28
  me?
• 5:28
  There are mechanisms for that.
• 5:29
  I had a bunch of questions about the ultimate use cases for crypto, but I was like, this
• 5:34
  isn't a place where you need us as a manager.
• 5:36
  The AI piece, it's harder.
• 5:38
  I just think this stuff is gonna take a lot longer.
• 5:40
  It's very hard to talk to LPs and have a point of view that's contrary to what most of the
• 5:45
  really smart people that have come into their office have told them as the future.
• 5:49
  So I've now started telling them, I agree with their view on the future.
• 5:52
  We're just arguing over the timeline.
• 5:53
  And I think even an early stage venture manager, being early is being wrong.
• 5:57
  I keep thinking like I worked at excite in the early 2000.
• 6:01
  Almost every good idea someone had that failed then works now.
• 6:05
  I ordered groceries on the Internet, but I don't order them from what van.
• 6:08
  I buy movie tickets, plane tickets.
• 6:10
  I basically do everything on the Internet, but I do very little of that activity with the
• 6:14
  first couple of companies that tried because the tech wasn't ready.
• 6:18
  There were so many things that had to fall in the place.
• 6:19
  And when I use a lot of these early AI products, I feel the same way, which is like,
• 6:23
  oh, yeah.
• 6:23
  I can see how with a few more cycles of iteration, this AI will solve this problem or
• 6:28
  will will largely address it.
• 6:29
  But in a lot of use cases, I'm like, but not today.
• 6:31
  And if not today, like, why this company?
• 6:33
  Why not somebody who starts it later when the technology is more capable?
• 6:36
  Why why won't that person win?
• 6:37
  I think it is hard to go into a room with a limited partner, and they're like, every other
• 6:41
  GP who's coming here has told me that they're all in on AI.
• 6:43
  It's one of the only things that are investing.
• 6:45
  And I'm like, yeah.
• 6:45
  We're not doing that.
• 6:46
  And people are like, why not?
• 6:47
  I'm like, well, here's why not.
• 6:48
  And they're like, wow.
• 6:49
  Well, who's right?
• 6:50
  You or them?
• 6:50
  I'm like, we'll find out.
• 6:51
  Maybe both of us are right.
• 6:52
  An early question that I wanted to ask you, it's really a double click on the broader SaaS
• 6:56
  valuations that the Euclid team did here on the fundraising environment over the years.
• 7:00
  And so according to Carta data, SaaS seed graduations are at a historic low, yet SaaS
• 7:05
  seed valuations are at an all time high.
• 7:07
  So the Euclid team attributes this money needing to, quote, work its way through the
• 7:11
  system with perhaps a glut of capital held in the steed stage.
• 7:16
  This could be due to boom era fund manager behavior where diligence was infrequent,
• 7:21
  traction was overlooked, and the deal piece was really unsustainable.
• 7:25
  So in short, more companies got seed stage funding than they should have, and those who
• 7:30
  were funded received more dollars than they should have.
• 7:32
  And I wonder, is this paralleled foreshadowing as it pertains to AI, just seeing the pace of
• 7:37
  deals that are being done for AI with little to no traction and underwriting mechanisms?
• 7:41
  I haven't quite figured out myself.
• 7:43
  I suspect the answer is yes.
• 7:44
  But depending on which companies you're in, it might not matter.
• 7:47
  If you're in the few that, like, get through the eye of the needle and win, does it really
• 7:51
  matter?
• 7:52
  But I don't see how it can't end in a similar way because there are a lot of these
• 7:56
  categories.
• 7:57
  There's 20, 30, 40, 50 seed stage companies pursuing the same idea.
• 8:01
  They can't all win.
• 8:02
  Also, I think people forget sometimes there's no winner.
• 8:05
  Everybody loses.
• 8:05
  Like, that is an outcome that can happen in a category or for a product type.
• 8:09
  Like, there can be no winner.
• 8:11
  I think about that a lot because I think if you open your mind to the idea that, like, this is
• 8:15
  a category that might produce no winners, you think differently than, oh, there will be a
• 8:19
  winner here.
• 8:20
  My job is to select and identify that company.
• 8:22
  And I think some of these categories, there just might be no winner because the technology
• 8:26
  is not fully up to the task or the customer is not ready to turn that over to AI just yet.
• 8:30
  So we'll see.
• 8:32
  I think the other thing, Nomiya, is seed used to be a very upper out investment stage.
• 8:37
  You got your seed around and then you went to do an a.
• 8:39
  If you couldn't pull off a series a, maybe you got a little baby extension or a bridge to go
• 8:44
  try and raise again in 2 quarters, and usually to address or fix some very specific
• 8:49
  shortcoming in the business.
• 8:50
  Now seed is a phase, to quote Hunter Walk.
• 8:53
  It lasts 4 years now.
• 8:55
  You get oftentimes 2 bites at the apple.
• 8:58
  We used to get answers on seed stage companies much faster.
• 9:01
  Now it just takes longer to get answers.
• 9:03
  Now the question is, will taking longer to get answers, will it work in the end?
• 9:06
  Does it just mean, oh, we're still gonna have reasonably high graduation rates.
• 9:08
  It's just gonna rates.
• 9:10
  It's just gonna take 4 years to graduate instead of 2.
• 9:12
  Or graduation rates are just gonna go down because graduation rates are fundamentally a
• 9:17
  function of the supply of series a capital, not the demand from start ups.
• 9:21
  And we have, in the last 10 years, dramatically increased the supply of seed stage startups
• 9:27
  because of all the new seed managers that are out there, including us.
• 9:29
  But the amount of series a capital has not grown at the same rate.
• 9:32
  I think it was Thomas Thomas who had a post a while ago.
• 9:35
  It was something like seed company formation is up 5 times more than series a dollars are up.
• 9:40
  And I'm like, well, that suggests to me that, like, those dollars are gonna become pickier.
• 9:44
  And even if they weren't pickier, there's just not enough money for all of those companies to
• 9:47
  get funded and graduated.
• 9:49
  And the question is like, well, how does that pain get distributed?
• 9:51
  And I think this year, the scary thing in the first half of the year was, like, okay.
• 9:54
  There's less money, and a disproportionate chunk of that money is only looking at
• 9:58
  enterprise AI.
• 9:58
  So if you are not an enterprise AI company, you are fighting for a very small sliver of
• 10:04
  available series a dollars.
• 10:05
  Since the market has become pickier, is it the responsibility if, like, our focus is on
• 10:11
  precedency to help and lobby and push and advocate for our founders who are going up to
• 10:16
  series a more and more?
• 10:17
  I feel like precursor threads the needle quite well on trusting founders to do things that
• 10:23
  founders are best positioned to do, and sometimes that means fundraising.
• 10:26
  But in this environment, what is the balance we have to strike?
• 10:31
  I think our job is to explain to people what the terrain looks like.
• 10:35
  We gotta have good binoculars.
• 10:36
  We have to be able to stand on the hill and look out and say, oh, if you decide to go
• 10:40
  fundraise, this is the environment you're walking into.
• 10:43
  And I feel like when it comes to our co investor partners, like, my job is to listen to
• 10:47
  what they're telling me.
• 10:48
  Like, I had a bunch of people who were just like, our firm is only doing enterprise AI.
• 10:51
  I'm like, seriously?
• 10:51
  That seems weird.
• 10:52
  He's like, I think it's weird too, but I'm just telling you, this is all I can get through
• 10:56
  right now.
• 10:57
  So if you send me stuff that, like, is not in this box, the probability that like anyone's
• 11:01
  gonna care is very low.
• 11:03
  I'm like, well, how long do you think this is gonna be the case?
• 11:05
  And this person said until it isn't.
• 11:06
  And I was like, okay, this is like actually information I need to share with our portfolio.
• 11:11
  And the nice thing is I tell people having a big portfolio can be a feature or a bug
• 11:15
  depending on what you do with with that.
• 11:17
  We try to make it a feature.
• 11:18
  And we have so many companies that are fundraising at any point in time.
• 11:22
  We get a lot of feedback and signal from people.
• 11:25
  And I've tried to convince people sometimes to see the world a different way, but I'm like,
• 11:28
  you know, you people at your firm who spend a lot of time talking to each other, coming up
• 11:32
  with a strategy and a thesis, I'm gonna take that as like a made decision and not one way
• 11:37
  you're looking for input or influence from me.
• 11:38
  I'm I'm approaching these meetings because this is a chance for me to learn what's happening at
• 11:42
  your shop.
• 11:42
  What do you wanna see?
• 11:43
  And I find that oftentimes what people wanna see is not what you read about.
• 11:47
  It's usually something different.
• 11:48
  So I'd say the biggest thing I've I've become more attuned to is as the market's gotten
• 11:52
  pickier, the allowances that VCs will give for any hesitations they have about the founder
• 11:57
  have gone way down.
• 11:57
  And this makes me kinda sad because there were people who got funded in 2020 and 2021 who
• 12:03
  needed some grace in the early days to figure things out.
• 12:06
  And they weren't perfect, but, like, a more accommodating capital environment gave those
• 12:10
  people, like, room and space to learn how to manage and be good.
• 12:14
  And I just think there are fewer people giving founders that opportunity.
• 12:17
  So I've tried to both be much more demanding in my assessment of founders, but not lose the
• 12:23
  optimism that people who don't have everything figured out yet can't become successful.
• 12:28
  And it's it's been hard, honestly, to, like, hold those two things at the same time and
• 12:32
  still pick the kind of founders that I think reflect our firm's values and strategy.
• 12:36
  It feels like if fundraising for a founder was like a road of which to be traveled by a car.
• 12:40
  We can't drive the car for you as an investor, but I can point out all the potholes,
• 12:44
  hopefully, that can help you navigate the road a little bit smoother.
• 12:48
  Moving on to topic 2 general panelists layers in financing to boost its fortunes by Strictly
• 12:54
  BC.
• 12:55
  So in this episode of Strictly BC, Hemant and Pranav from General Catalyst discuss how they
• 13:01
  are layering financing into its strategy to bolster its investment portfolio's long term
• 13:06
  success.
• 13:07
  This includes moves like acquiring other seed funds, buying a hospital system, and creating
• 13:12
  unique financial instruments and beyond.
• 13:15
  And so this feels very PE focused, and the interviewers actually ask GC in the beginning,
• 13:21
  essentially, do they consider themselves a venture capital firm still with all the
• 13:25
  different strategies that they are deploying?
• 13:27
  And their response was more or less along the lines of time will tell.
• 13:30
  GC is one of the most recognizable funds across venture.
• 13:33
  And in true fashion, I I always find that investors love to mirror and follow behaviors
• 13:37
  and herds.
• 13:38
  So, Charles, do you think more funds will try and follow suit and try to mirror this type of
• 13:45
  diversified investment and management strategy?
• 13:48
  Yes.
• 13:49
  In the simple the simplest answer, Mia, is yes.
• 13:51
  And I think the motivations will be different.
• 13:54
  But I think if you zoom out, venture capital is, like, not a very elastic asset class.
• 14:00
  So if you're a firm that is growing and LPs wanna give you more money, at some point,
• 14:04
  you're like, well, I have all the money I can deploy against first checks.
• 14:08
  I have all the money I can deploy against growth.
• 14:10
  What other problems in the ecosystem of finance can I solve for the founders that we work with?
• 14:17
  And I think that history of almost all finance is that big firms get bigger.
• 14:21
  If you look at the buyout world, you know, the big buyout firms used to be big.
• 14:25
  Now they're enormous.
• 14:26
  You look at almost any segment of finance over time and venture is going through this now.
• 14:30
  And I think it was interesting with the direct lending thing, like, just hearing them talk
• 14:34
  about the rationale was like, hey, we had companies that we were meeting that were
• 14:37
  spending a bunch of money in a way that we thought was an inefficient use of I'm
• 14:41
  paraphrasing, an inefficient use of equity.
• 14:43
  And we thought we could offer them a better product.
• 14:45
  And I'm just fascinated that, like, it feels to me almost overnight, venture capital went from
• 14:50
  this, like, weird corner of finance where we don't do anything that the other people do.
• 14:53
  We don't do secondaries.
• 14:55
  We don't do continuation vehicles.
• 14:56
  We don't do dividend recaps.
• 14:58
  We don't have all these other exotic products.
• 15:01
  And then one day I woke up and everyone's like, just kidding.
• 15:03
  We do all of those things now.
• 15:04
  And I think it's just fascinating to watch our industry, which I feel like has always been a
• 15:08
  part of finance and apart from finance at the same time, Start to adopt more of the behaviors
• 15:13
  of our colleagues and peers in the broader private equity ecosystem.
• 15:17
  And this is all new for us.
• 15:19
  Maybe not for all of us, but I'd say as a group, these are new things for venture
• 15:23
  capitalists to introduce.
• 15:25
  I think the big funds are uniquely able to try these things because of their unprecedented
• 15:29
  access to capital.
• 15:30
  GC is also buying a hospital.
• 15:32
  I think it's really cool.
• 15:33
  Himant, like, walked a bunch of us through the logic.
• 15:35
  I thought it was, like, an interesting argument for maybe the easiest way to show people the
• 15:40
  promise of digital health technologies instead of like arm wrestling with the hospital CEO
• 15:45
  about why they should deploy this stuff.
• 15:47
  Just buy a hospital that you control and deploy this stuff yourself.
• 15:50
  That wouldn't have been a solution people would have pursued previously.
• 15:54
  So I'm just fascinated by, like, what's the limit?
• 15:56
  And how much non venture stuff can you do and still call yourself a venture capitalist?
• 16:00
  And even more interesting, at what point would a firm like GC be better off not calling itself
• 16:05
  a venture capital firm?
• 16:06
  At what point is the venture capital moniker or label actually limiting to your firm's ambition
• 16:11
  and, like, limiting in terms of, like, the things that you'd like to get into?
• 16:14
  For the listeners, what Charles was touching on was GC's customer value strategy vehicle.
• 16:18
  It's a funding model where the firm will prefund a company's customer acquisition cost,
• 16:23
  essentially assumes the costs of sales and marketing.
• 16:25
  In exchange, GC takes a capped return based on the customer value generated from that initial
• 16:30
  investment in lieu of equity, and they actually bear the entire risk in an underperforming
• 16:34
  market.
• 16:34
  So this is created to help companies create a stronger cash flow and then grow, scale, and
• 16:39
  ultimately return DPI to investors.
• 16:41
  I guess one more question for you.
• 16:43
  If this strategy ends up being carried out more frequently across different funds, how am I as
• 16:48
  an investor supposed to now look at those metrics?
• 16:51
  Am I supposed to ignore the fact that sales and marketing is placed off of the balance sheet?
• 16:55
  Like, how do I actually think about progress and metrics now?
• 16:58
  I have been struggling with this very question.
• 17:02
  I don't know.
• 17:02
  I I this is one of those things where it's just like, what would I do if a company with this
• 17:06
  structure walked into my office?
• 17:07
  I think we saw a little bit of this when sort of capchase pipe, where we had this sort of
• 17:13
  revenue based financing.
• 17:14
  And I think for most investors, it was kind of easy to understand because oftentimes the
• 17:19
  underwriting for those things was coming from previous financial performance.
• 17:23
  And people were like, oh, this is like money that still needs to be paid back.
• 17:26
  And I think there was some understanding.
• 17:28
  But I think this is really different.
• 17:30
  And I think it's gonna impact, like, how companies think about raising equity capital.
• 17:33
  And if you have this vehicle, like, does it change the way you think about how much equity
• 17:36
  capital you need?
• 17:37
  So venture capital is becoming more financial, which is something I just didn't think was
• 17:40
  gonna happen 5 years ago.
• 17:41
  I was like, we're this, like, little weird cottage industry that's like more psychology
• 17:46
  than finance and that's that era maybe has also come into a close.
• 17:50
  Well, we are all out of time.
• 17:51
  Thank you, Charles, for hopping in.
• 17:53
  Thank you for all our listeners for popping by the Learning Corner.
• 17:56
  Please share and subscribe, and we will all see you next week.
• 17:59
  Thank you.
• 18:00
  Bye.