Latest / The Learning Corner by Precursor / Episode #14: The Information, TechCrunch, LifeSciVC (shared by Jay Ripley)

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Episode #14: The Information, TechCrunch, LifeSciVC (shared by Jay Ripley) · The Learning Corner by Precursor

• 0:00
  In venture, you get paid 2 different ways, management fees, which are really, in my
• 0:04
  opinion, alone against future performance.
• 0:06
  You will have to pay them back before you get carry.
• 0:08
  And then carried interest based on the quality of the investment decisions you make.
• 0:11
  But as one of my favorite VCs told me once, management fees showed up today and Carrie
• 0:16
  shows up 10 years from now.
• 0:17
  It's the week of January 6th.
• 0:19
  Welcome to the learning corner, a Precursor Ventures podcast.
• 0:27
  Welcome to the Learning Corner by Precursor, and happy first episode of the year.
• 0:32
  I'm Mia Farnham, and I am joined by our GP and managing partner, Charles Hudson, where we will
• 0:37
  be talking through the articles and Goodreads that caught our team's attention over the past
• 0:42
  week.
• 0:43
  The first article of the year is a recent event that happened over the holidays from The
• 0:47
  Information titled accounting startups sudden shutdown adds to startup woes.
• 0:52
  This story covers the unexpected shutdown of Bench, a well funded accounting startup, which
• 0:58
  has since been acquired by a competitor, Employer.com.
• 1:01
  While there was somewhat of a smoother landing that Bench had, the highlights from the
• 1:05
  article's spotlight, another tale on how startups with significant funding, nearly a
• 1:09
  100,000,000 in Bench's case, can still run into issues like cash flow mismanagement, market
• 1:14
  misalignment, or flawed growth strategies.
• 1:17
  So it's a cautionary tale for founders about scaling responsibly and maintaining that
• 1:22
  operational discipline even when fundraising has been successful.
• 1:25
  And it takes being fully immersed in the venture and startup world to truly understand
• 1:30
  this, but most people think that smoke and mirrors mostly happen at the earliest stages of
• 1:36
  investing, but I would actually argue it's in the later stages that have far more of that
• 1:40
  activity because there's so much more to lose.
• 1:43
  Before the new year, Bench was responsible for the accounting capabilities of more than 35,000
• 1:48
  American small business owners, had raised a 100,000,000 in funding, split between debt and
• 1:53
  equity, which we'll get into a little bit later, and had over 600 people employed at the
• 1:57
  company.
• 1:57
  So my question for you, Charles, is when are we as investors and founders able to exhale if at
• 2:05
  all?
• 2:05
  Boy, I just remember I saw Natasha's article pop up, and then I went to our Slack channel.
• 2:11
  And immediately, someone's like, have you guys heard about Bench?
• 2:13
  I was like, uh-oh.
• 2:14
  What's happening here?
• 2:15
  And when I read the notice, there's only two reasons the company shuts down abruptly like
• 2:20
  that with no notice even to employees.
• 2:23
  1 is, like, a hail Mary m and a event that you thought was gonna go through that fell apart
• 2:28
  and you just can't operate.
• 2:29
  And the second one is some kind of debtor financial covenant that you've tripped, and
• 2:34
  you've lost the support of your lender.
• 2:36
  And they have decided to call the money immediately, and you sent them the keys.
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  And you really don't get much notice with that.
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  And I think Shiel from Better Tomorrow was the first person I saw online who was, like, based
• 2:48
  on all of this, my guess knowing nothing about the situation is a debt covenants issue.
• 2:52
  This is why I've always been very wary of recommending venture debt to our portfolio
• 2:58
  companies that aren't already very close to operational breakeven or maybe even profitable
• 3:03
  because venture debt is a great tool until you get into trouble.
• 3:08
  And then it's like if you see a drowning man, you throw him a hose.
• 3:12
  It's like just as things are getting bad and you need more relief, things get tighter faster
• 3:16
  because lenders want their money back, and they're more interested in capital preservation
• 3:20
  than equity holders who are looking for upside.
• 3:22
  And I think this is just another tale of a company that, from all I've read, it sounds
• 3:27
  like got into a position where 2 things happened.
• 3:29
  1, I think there have been a lot of calls for these tech enabled services businesses.
• 3:34
  The technology can make you more efficient and more scalable and allow you to support more
• 3:38
  customers, and it sounds like maybe Bench hadn't quite gotten the tech to work to the
• 3:42
  degree that it needed to to be more efficient.
• 3:45
  And when you're playing with venture debt and you get to the place where you've lost the
• 3:48
  confidence of your lender, it's over for you.
• 3:50
  And I've had this happen for our portfolio companies where everything's been good on
• 3:54
  Friday.
• 3:54
  And on Monday, we've come in and the company said we're sweeping the account.
• 3:58
  We're calling the loan, and that's it.
• 3:59
  And for folks listening to the podcast, covenants are a new term for them, essentially,
• 4:03
  venture debt, which is fairly common within growth stage investing.
• 4:07
  Like, I find that that is kind of like a common split or at least something on the table that
• 4:11
  founders think about when they're raising subsequent rounds.
• 4:13
  But, essentially, covenants are legally binding agreements that you have as taking on this
• 4:19
  amount of money.
• 4:19
  The covenants there could be anything from how much cash you have in the bank, what your
• 4:24
  revenue has to look like, to what your board looks like, or specific investors who are gonna
• 4:29
  come into the round.
• 4:30
  And so any sort of fault in confidence there could result in exactly what you said, Charles,
• 4:35
  of them demanding a complete repayment of the loan.
• 4:38
  Bench's shutdown highlights how even well funded startups just aren't immune to financial
• 4:43
  struggles.
• 4:43
  And I feel like the natural question to you would be, how do you make sure founders are
• 4:48
  able to scale effectively and forecast all these changes?
• 4:51
  But my real question that I'd rather ask you is, how do you ensure founders are actually
• 4:55
  being transparent with you on the struggles that they're encountering and continue to share
• 5:00
  these in some of the more tumultuous moments in their journey?
• 5:04
  I think it's really hard.
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  I think it all starts with trust.
• 5:07
  If you can get founders to trust you, and I think you have to build trust over time, and as
• 5:12
  you've heard me say, almost every interaction you have with the founder, you're either
• 5:14
  building trust or destroying trust.
• 5:16
  It's very rare that that interaction is neutral.
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  I do think it sounds like from everything I've read, the investors were, like, actually pretty
• 5:22
  involved is that the company got itself into a place where it was in quite a pickle for
• 5:27
  getting itself out.
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  And one thing I always worry about is when the startup companies that are doing things in
• 5:33
  bookkeeping or health care or insurance is how many times can you have companies like this
• 5:39
  blow up before start ups just say, this is too risky.
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  I think I'd rather go with maybe a less tech enabled, less sexy provider rather than take
• 5:49
  the risk on a start up.
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  I think part of the reason I've always been skeptical of our seed stage companies taking
• 5:54
  venture debt is because the level of sophistication required to run the business
• 5:58
  with venture debt is really different.
• 6:00
  And if you start dipping into venture debt as a way to extend runway or as a way to do other
• 6:04
  things, you get into these situations where, as you put it, you're you're closing it on a cash
• 6:09
  covenant or maybe you miss the revenue covenant, and very quickly, the business is no
• 6:13
  longer yours.
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  It belongs to the lender, and you're only able to operate as long as they believe that you and
• 6:18
  your investors will support the business and get it to a place where they're gonna get their
• 6:21
  money back.
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  And I think a lot of founders I've worked with quickly realized that debt behaves very
• 6:26
  differently than equity as you get closer to that zero cash date.
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  And so I don't know.
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  We've had a couple of cases where I'd say we've had founders who've gotten themselves into
• 6:33
  trouble because they genuinely didn't their financials and didn't understand the
• 6:38
  implications of things like venture debt or other types of loan vehicles.
• 6:41
  It's very rare that I've had people intentionally mislead me about the company's
• 6:45
  finance performance.
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  It reminds me about rev share loans, which I can feel the operator side of this being like,
• 6:50
  well, I took those vehicles because I was not getting the buy in from traditional venture,
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  and you told me to get more creative with how to raise money.
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  And so I did that because venture was telling me to look elsewhere.
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  But to your point, the more important part is continuing to be really vigilant on what you're
• 7:08
  looking at in terms of the dollars that you're bringing into the business and being really
• 7:12
  sure that you have the right amount of revenue traction and chops to put it to work.
• 7:17
  Our second topic comes from TechCrunch.
• 7:20
  It's titled Silicon Valley is so dominant again, its startups devoured over half of all
• 7:25
  global VC funding in 2024.
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  The article explores Silicon Valley's resurgence as the global epicenter for venture
• 7:31
  capital with its start ups capturing over 50% of all VC funding globally in 2024.
• 7:37
  It's a massive comeback after a few years of relative geographic diversification and
• 7:42
  funding.
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  And so this shift highlights how emerging hubs struggle to maintain momentum as macroeconomic
• 7:48
  uncertainty kinda pushed back to the valley's well established ecosystem.
• 7:52
  And the concentration of funding in sectors like AI, which have deep roots in the valley,
• 7:57
  also naturally contributed to this recentralization.
• 8:00
  Charles, I'm curious how you interpret this resurgence of Silicon Valley's dominance.
• 8:04
  Is it a sign that innovation is best supported by concentrated ecosystems, or do you think
• 8:08
  it's, you know, a temporary reaction to broader market uncertainty around venture and wanting
• 8:12
  to return to something that they know is tried and true.
• 8:14
  A couple things are happening here.
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  One is, I think if we look at AI, probably 2 of the most important companies in the AI, because
• 8:21
  it's some open and anthropic, are both based here.
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  I think that creates gravitational pull.
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  I think a lot of things happen.
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  YC went back to in person here in San Francisco.
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  But it's interesting.
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  I think while I've seen a lot of the return to office stuff that's happened has been led by
• 8:35
  the company leadership, my experience has been a lot of the recent realization in San
• 8:39
  Francisco has been led by founders, not VCs.
• 8:42
  About a year ago, I noticed a lot of our top highest performing companies made the decision
• 8:46
  that people were gonna come back in office here in San Francisco 3 plus days a week.
• 8:51
  And a lot of them said, anyone who doesn't want to do that, we totally understand, understand,
• 8:56
  but that's what we're doing.
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  And I talked to a lot of them about this, about why they were doing this.
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  A lot of them said, we don't feel like we figured out how to be as effective as a remote
• 9:04
  organization as we were in person.
• 9:05
  And then I started looking at the data in our portfolio, and I was like, wow.
• 9:08
  Finding product market fit 0 to 1 is very, very hard.
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  If you add distance to that between a team, you've taken something that's really hard and
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  made it even harder.
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  And if you take distance plus a lack of shared priors, you've taken something that's really
• 9:22
  hard and made it extraordinarily hard.
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  I've been doing this experiment that I call, like, field trips, where I've been bringing
• 9:27
  founders from other ecosystems to come work out of our office in San Francisco for a week.
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  And it's been eye opening, Mia, because a handful of people have been like, I don't know
• 9:36
  what I'm missing.
• 9:37
  First of all, it's not the principal's office.
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  You're not in trouble.
• 9:39
  Yeah.
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  I just want you to come here and experience what it's like to be here.
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  And the most common thing I hear from people is I got more done in a week here than I got them
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  done in a month at home.
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  And I'm like, why?
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  They're like, well, I went to dinner with a bunch of founders at a restaurant in Hayes
• 9:54
  Valley, and I told everybody I had a problem.
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  And somebody texted their friend at dinner, and the next day, I had coffee with that person,
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  and they solved my problem.
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  Not only did they solve my problem, they introduced me to 3 other people who also could
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  help me solve my problem.
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  And I think you just can't beat the speed with which information travels in the valley, the
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  connectivity, the proximity to capital.
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  I just think, you know, a long time ago, I told people you can be an actor anywhere in the
• 10:21
  world.
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  They make movies and plays everywhere.
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  I just think it's easier if you're in LA.
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  And, you know, I have some friends who are, like, hedge fund people in San Francisco, and
• 10:28
  that works.
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  But I think, like, the center of gravity for that business is New York, and every business
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  has a center of gravity.
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  I don't think this is unique to tech.
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  Everything you're trying to do is easier when you're in the place where there's a density of
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  connections, talent, and information.
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  And I think there was a hope coming out of the pandemic that we would end up with something
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  more decentralized.
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  And I think the pro cases, those non Valley hubs are healthier and better than they were
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  beforehand in most cases because not everybody who went there left.
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  But I think it feels to me like most people have concluded that the Valley is still the
• 11:02
  best place, not the only place you can start a great company or but it's the best place to
• 11:07
  start and build companies.
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  And I feel really strongly about that preproduct market fit.
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  And even our data has said, like, our portfolio has become more Silicon Valley centric, again,
• 11:16
  relative to what it looked like during the pandemic.
• 11:18
  I mean, I'm a huge supporter of, obviously, New York, the ecosystems and emerging ecosystems,
• 11:23
  but it's impossible to not acknowledge how palpable it feels of time effectiveness when
• 11:29
  you're in the Bay Area.
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  And I would actually encourage founders who are located elsewhere to do kind of like replicate
• 11:34
  a field trip and go to the Bay Area and try and feel it yourself of sitting in a blue bottle in
• 11:39
  Jackson Square and just having coffee meetings there, the amount of people that you find who
• 11:44
  are in your similar lane or in adjacent spaces that are getting coffee at the same time is
• 11:49
  much higher than most other spaces.
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  I used to live in Denver.
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  And in Boulder, of course, there's like a growing and scrappy startup scene, but it's, an
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  hour drive from Boulder to Denver, which is where most people live.
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  And some people aren't hanging around in the coffee shops as much as they are within Jackson
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  Square or even the Cow Hollow, like Pac Heights where people live.
• 12:09
  Question for you, Charles, any advice that you have for folks who are tied to their emerging
• 12:14
  hubs?
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  The one thing I think we won't go back to is, you know, I I walked past the Twitter building
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  the other day, and I was like, wow.
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  Twitter used to have a lot of people in that building.
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  And I don't know if they all needed to be in San Francisco on 10th and Market.
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  I don't.
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  I think there was this thing where, like, not only did you have to start in San Francisco,
• 12:32
  you had to scale in San Francisco.
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  I don't believe we're gonna go back to an era where you need to be here for the entirety of
• 12:38
  your journey and for the entirety of your company.
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  So I think pre product market fit, when you're figuring things out, this is great.
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  But I think we're gonna have companies that start here and have hubs in New York and LA and
• 12:50
  Denver and Austin, and it's gonna be fine.
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  I also think I meet more and more companies who just say, hey, we did our last company remote.
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  It turned out really well.
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  We all know each other.
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  We have really good work hygiene and practices.
• 13:01
  We can make this work, and they will succeed.
• 13:03
  So I think there'll be more heterogeneity.
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  At the minimum, if you told me, I have 2 choices.
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  We could be in the Bay Area or we could be in the same place, but not the Bay Area or we
• 13:12
  could be remote.
• 13:12
  I'd be like, being in the same place, not the Bay Area is probably the 2nd best alternative
• 13:17
  because you get many of the benefits of the proximity with your team, but you don't get all
• 13:21
  the information spillover.
• 13:22
  Our final article is from the Lifesci VC blog by Bruce Booth titled Atlas 14 and Reflections
• 13:29
  on the VC Math Problem.
• 13:31
  So thank you to Jay at Global Endowment Management for sharing with the Precursor team.
• 13:36
  In the article, Bruce explores the unique challenges of delivering strong venture capital
• 13:40
  returns, particularly for a large funds like Atlas 14, which recently closed at 800,000,000.
• 13:45
  What's especially notable is that Atlas chose to raise a smaller fund with Atlas 14 than its
• 13:52
  prior fund.
• 13:53
  It was around 900,000,000.
• 13:54
  This is a departure, obviously, from the industry norm where larger successful funds
• 13:58
  often lead to even larger subsequent raises.
• 14:00
  Atlas made this decision intentionally citing the difficulty of maintaining high returns as
• 14:05
  fund size increases and the need for discipline in deploying capital, all things we've talked
• 14:08
  about before in the podcast.
• 14:10
  The article also dives into this VC math problem, how a fund size, target ownership, and
• 14:15
  exit multiples must align to deliver your top quartile returns.
• 14:19
  And so for those larger funds, the math becomes even trickier.
• 14:21
  So we've talked about this sentiment many podcasts ago where you only raise smaller
• 14:27
  subsequent funds because you have to.
• 14:28
  And so whether or not you believe in that sentiment, do you think that larger, more
• 14:32
  seasoned funds making the decision to size down subsequent funds will actually encourage
• 14:37
  smaller funds, maybe those who are using fund 2, fund 3, fund 4, to really think through the
• 14:42
  target size now that they're seeing some maybe more seasoned veteran funds do so.
• 14:47
  I hope it creates space for that conversation.
• 14:50
  This is a plug.
• 14:50
  Every quarter, Jay and the team team at Global Endowment sends out 5 articles that are worth
• 14:55
  reading, and then I don't know if they take outside subscribers to the list, but it's
• 14:59
  really they're always amazing articles.
• 15:01
  And this one caught my attention because I think so many times we talk about the math
• 15:04
  problem in venture as being only a software tech VC problem, and it's not.
• 15:09
  It's a venture problem.
• 15:11
  And the thing I liked about this article is he talks about, like, look, this is the scale of
• 15:14
  exits that we've seen in our category.
• 15:17
  So if you're gonna raise a much larger fund, you have to believe that something about the
• 15:22
  future will be different than the past.
• 15:24
  Otherwise, you're probably just gonna have lower returns, and we could spend 3 weeks of
• 15:29
  learning corner talking about the different incentives between management fees, carried
• 15:33
  interest, fund multiples, all of that stuff.
• 15:35
  Suffice it to say in venture, you get paid 2 different ways, management fees, which are
• 15:40
  really, in my opinion, alone against future performance.
• 15:43
  You will have to pay them back before you get carried.
• 15:45
  And then carried interest based on the quality of the investment decisions you make.
• 15:48
  But as one of my favorite VCs told me once, you know, management fees show up today, and Carey
• 15:53
  shows up 10 years from now.
• 15:54
  So the incentives to raise a bigger fund are clear.
• 15:58
  I think it just like a startup that wants to show things going up into the right, a lot of
• 16:01
  VCs wanna show fund size up into the right.
• 16:04
  Because to some extent, people offering you more money is a signal that they think you're
• 16:08
  doing something right.
• 16:09
  And I think in life and personal relationships and professional relationships, when you're
• 16:14
  explaining, you're losing.
• 16:15
  And in most cases, when people raise a smaller fund, the first thing they wanna do is tell you
• 16:19
  that it was their choice or that they made a decision.
• 16:22
  This piece felt like it was well thought out.
• 16:24
  So I think the market, though, Mia, is also solving some of this problem for early stage
• 16:29
  managers because in 20 20, I talked to a lot of people who are like, well, I'm gonna do a
• 16:33
  $10,000,000 first fund, and I'm gonna do a 50 or a $100,000,000 second fund.
• 16:37
  Then I'm like, that's not even the same business.
• 16:40
  I wouldn't recommend you do that.
• 16:42
  And the market, I think, has largely solved that problem for them.
• 16:44
  But I think a lot about what about our model changes kind of in increments of $25,000,000
• 16:50
  And we've run a sub $25,000,000 version of precursor, a $50,000,000 version of precursor,
• 16:55
  a roughly, like, $75 ish million version.
• 16:58
  And believe it or not, all three of those funds felt really different in terms of first check,
• 17:03
  reserves, scale of outcome we need to move the needle, and that's at, like, relatively small
• 17:08
  gradations of difference.
• 17:09
  And it's sort of taught me that there's an optimal fun size for our strategy.
• 17:13
  And I don't really think we will push above that because I don't really wanna know what's
• 17:16
  on the other side.
• 17:17
  And I really hope that at some point, we can decouple fun size and AUM from ego.
• 17:23
  I would be lying if I said I think that's gonna happen anytime soon.
• 17:28
  But the thing I really liked is Bruce really does explain, if you're gonna raise a big fund,
• 17:32
  you have to really believe that the future exit scenarios for your industry I I look at all
• 17:38
  these multibillion dollar funds we have on the software side, and I'm like, if AI produces
• 17:43
  many more $25,000,000,000 plus software companies than cloud or on prem software did,
• 17:50
  there is no problem.
• 17:51
  There's actually no problem.
• 17:52
  There's plenty of returns to run.
• 17:54
  If the future looks like the past, it is gonna be much harder for all of those funds to do
• 18:00
  well because there won't be enough aggregate $25,000,000,000 plus exits for people to have
• 18:05
  the kind of returns they need.
• 18:07
  I just thought it was nice to read about, like, people in biotech and life sciences have the
• 18:11
  same problems too.
• 18:11
  Going back to one of your earlier points, you know, I think one of the parts of this article
• 18:15
  that's really interesting is that he's able to include all of this data on m and a activity
• 18:20
  across biotech, which is what they're focused on from a historical perspective, which is
• 18:24
  really key in laying the logic of why the fund is the size that it is.
• 18:28
  In parallel, exactly what you were saying before, while, yes, generative AI has been
• 18:35
  around in theories in like, the sixties, generative adversarial networks have really
• 18:39
  only been around for a handful of years, I think, since, like, 2014.
• 18:42
  And so there are many funds being raised with massive targets without having historical exit
• 18:47
  data points to reference to quite yet.
• 18:49
  So to your exact point, we're almost, like, waiting for the validation on those fund sizes
• 18:54
  to make the math even math.
• 18:55
  Like, there's no math actually to reinforce that quite yet.
• 18:58
  I hope it all works out because that would be a big win for venture in general.
• 19:03
  I would hope that will reinstitute a lot of excitement about investing in the space and
• 19:07
  being excited about exploring new emerging markets.
• 19:10
  But I'm curious.
• 19:11
  How should fund managers balance optimism about emerging sectors with the discipline that comes
• 19:15
  with relying on historical exits and comps?
• 19:17
  Yeah.
• 19:18
  I just I talked to one of our portfolio company founders who just raised a big round over the
• 19:23
  holidays, and I really hope that this works out.
• 19:26
  It's a really great company, but it has already exceeded what I thought it would be worth at
• 19:30
  the end of the day, and it's still private.
• 19:32
  So I think we'll find out, but maybe not for a couple years.
• 19:35
  Well, we are all out of time for today.
• 19:38
  Thank you, Charles, for coming into Learning Corner.
• 19:40
  Welcome back to all of our listeners.
• 19:43
  Share, like, and subscribe, and we will talk to you all next week.