Latest / The Learning Corner by Precursor / Episode #9: Jamin Ball, Hunter Walk, Menlo Ventures

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Episode #9: Jamin Ball, Hunter Walk, Menlo Ventures · The Learning Corner by Precursor

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One fact that I remind every portfolio company of ours, whoever's money you take, you are
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buying into their business model.
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I think there is a bunch of founders I've met who've taken money from funds where they didn't
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fully comprehend that winning for that fund meant not 500,000,000, not a 1,000,000,000, but
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$5,000,000,000 outcome.
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It's the week of November 18th.
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Welcome to the Learning Corner, a Precursor Ventures podcast.
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Welcome to the Learning Corner by Precursor.
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I'm Mia Farnham, and I'm joined by our GP and managing partner Charles Hudson, where we will
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be talking through the articles and Goodreads that caught our teens' attention over the past
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week.
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Topic number 1, our first article comes from Jammin Ball's newsletter, clouded judgment
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titled misaligned incentives.
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Jammin also joined the podcast This Week in Startups to elaborate on what he wrote.
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He dove into the structural misalignment between venture capitalists and founders around
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fundraising and growth expectations.
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Jammin calls out the differences in how founders and funds can be successful.
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For founders, it will always be growing and exiting a larger company while maintaining a
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decent ownership percentage.
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For funds, we share the interest of a successful exit, but also can see financial
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success in management fees.
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The classic 2 and 20 makeup, Jammin argues that misaligned incentives often lead to decisions
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that aren't in the best interest of the company's long term success.
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But Jammin, similar to other investors, also warns founders about raising too much money too
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soon for all of the same reasons that if you were in the venture space between 2020 and
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2022, you probably also share that POV, but he wants founders to question, is the highest
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valuation offer from an investor taking place because they are the most convicted or because
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of the inherent misalignment in quote, unquote success, and they are playing a deployment
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game.
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I doubt that there are ICs taking place where partners are full blown agreeing to write 50 to
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$100,000,000 checks because they simply need to move money, but I do think some funds just have
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more flexibility into loose underwriting processes.
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But wanted to get your perspective, Charles, on that entire dynamic and also maybe what
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conversations with founders might have looked like in our own portfolio who maybe have
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encountered this fork in their own.
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Like, what questions go on in their brain?
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I have so much to say about this, Mia.
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I think first and foremost, I think it's really hard to convince founders to take a lower
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valuation unless there's a a real mitigating circumstance.
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So in most cases, I wouldn't always say that the highest offer or bid is the bid that wins
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in our competitive rounds.
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I would say most of the bids tend to be clustered in a pretty tight range.
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And I think the only time I've been able to convince founders successfully to raise money
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on a lower valuation is when the person making the offer has essentially a sterling reputation
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or brand.
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So, you know, if it's a Sequoia coming at a price that's below other folks, given their
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track record of success, given what I've seen them do to support companies, there are some
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founders who will decide to take that.
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Candidly, there are other founders who are just like, all of you VCs make promises ex ante.
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There's no take backs.
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I have no way to know whether any of you will do any of the things you've promised to do in
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terms of value add after I take the money.
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So why not just take the highest offer and deal with the consequences later?
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I think most founders on the one hand can intellectually say raising too much money at
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too high of a valuation is a bad thing in the abstract.
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And most confident founders I know say, but that will never happen to me or my company.
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That will happen to somebody else whose company is not as good and where the investors
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overpaid.
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2nd, I think VCs, we compete with each other on a lot of dimensions.
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One of those dimensions is price and valuation.
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And I think there's a lot of firms who say I am willing to pay up to win that deal.
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I remember when Greylock did Facebook at a $10,50,000,000 post, and everyone's like, how
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do you underwrite that?
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Turns out that was a pretty great investment.
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I think about when I think it was Keith who did Stripe at a billion.
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It was relatively early.
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A lot of people said, gosh.
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A $1,000,000,000 for Stripe.
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Like, how have we gotten ahead of ourselves?
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Turns out that'll probably be a pretty good investment.
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Early investors in OpenAI probably feel pretty good about where they sit right now.
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I would separate the question of, like, talking founders into lower valuations is very
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difficult because also founders exist in a community where sometimes valuation is vanity.
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I know people who do wanna be able to go to the cocktail party and tell their friends, oh, you
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raised at 200.
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I had similar metrics and I raised at 450.
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And that absolutely happens.
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So I think it takes a very evolved founder to say, I'm gonna forecast the future state in
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which I'm gonna regret this decision, and rather than deal with it then, I'm gonna deal
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with it now by taking a lower valuation.
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So that I think is just a hard conversation to have.
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The other thing I'll say is it's important to think about one fact that I remind every
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portfolio company of ours when they go to take money.
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Whoever's money you take, you are buying into their business model.
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So whatever the dollar they give you needs to do under their model, you need to live up to
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that.
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I think there is a bunch of founders I've met who've taken money from funds where they didn't
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fully comprehend that winning for that fund meant $5,000,000,000 outcome.
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Not 500,000,000, not a 1,000,000,000, but $5,000,000,000 outcome.
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And for those funds, they're moving money in large blocks, and their view is, hey.
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We need to find companies that we think have a good probability of getting to $5,000,000,000
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because nothing else matters.
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The other thing I took away from both the article and the podcast is it's important to
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remember, as a venture capitalist, you have a portfolio.
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You're making n number of investments per fund, and you need a very small fraction of them to
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work out.
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If you're a founder, you have one bet.
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And so if you've got a big venture fund, you're gonna make a lot of money on fees.
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And if you find a few home run companies, you'll also make a lot of money on Carry.
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If you're a founder, you only have one shot.
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You have your ownership as a common shareholder sitting behind preferred in order to make
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money, and it's just a different calculus.
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There might be outcomes for a founder who raised at a high valuation that are interesting
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to you personally, but do not achieve the objectives of the fund that you raise money
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from, and that always creates friction.
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And I think the VC business is a business of outliers.
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It's trying to find these rare companies.
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And if you're not one, life is hard.
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The last thing I'll say is as funds have gotten bigger, it's not that I think people have
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pressure to deploy.
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They certainly have more people writing checks, and the ability, as you mentioned, to be
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flexible on valuation has gone way up.
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And I see this a lot in c, where for a multibillion dollar venture fund, doing a
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$5,000,000 seed round on 50,000,000 post doesn't really matter because if that company
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does well, you're gonna buy up in the a.
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And if it doesn't, losing 4,000,000 out of that $5,000,000 round in a multimillion dollar fund,
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it's a rounding error.
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But if you're a price sensitive seed fund, you can't do that.
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What I've seen is, like, as funds have gotten bigger, the need to deploy capital has gone up.
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So, you know, if you're gonna write a $50,000,000 check into a company, that puts
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kind of a floor on what the valuation's gonna be in order for it to make sense for both the
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founder and the check writer.
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And to me, that naturally pushes valuations up.
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So some of this, I think, is also just driven by the supply and demand dynamic with capital.
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There's a lot more money chasing good companies, so the good companies, I think, get
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bit up.
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I think it's good to highlight the differences in the way that VCs and founders make money,
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but I found it very difficult to convince confident founders that they're gonna end up
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regretting taking a high valuation, particularly from a great firm.
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And I think the last thing I'll say is we still don't know what's gonna happen with all of the
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hedge fund growth equity money that came in 2019 through 2021, whether that's SoftBank,
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Kochu, Tiger, we still don't really know what's gonna happen with all the companies that took
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that money in terms of outcome.
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So I'll be curious to see whether there are founders that really regret that.
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So much of it is more theory versus reality.
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Jammin was talking about when you're a rocket ship type of company, you shift from this
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transition of originally hiring a bunch of missionaries.
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So the people were so passionate and so tied to what the company is trying to build that they
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couldn't imagine themselves doing anything different to becoming something so well known
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and and perhaps overvalued that maybe you start attracting mercenaries.
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People will see the value in the upside in joining the company.
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He's talked a little bit about the perils there.
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Again, more in theory versus what happens in reality.
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I know a bunch of startups who would love to have great mercenary employees.
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So think your top engineers at a massive tech company come and sit with them for a month and
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then leave.
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I agree with a lot of what Jammin said, but then I also try to apply it back from what
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actually happens in the real day to day world of a company.
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I tell so many companies, there's only 2 startup hiring problems.
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One problem is when your company is unknown, you literally cannot get the attention of the
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people you wanna hire.
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And then when your company is believed to be a sure thing, you have to work really hard to
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keep the wrong kind of people out of your company.
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And you're in one state or the other.
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I've seen people flip, and they're like, wow.
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We're getting all of these great resumes all of a sudden.
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People who wouldn't reply to our LinkedIn messages are suddenly, like, cold emailing me
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as the CEO, and I'm like, just be careful.
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Those people now think your company is a safe bet, and they're gonna bring a different kind
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of energy than the people you were hiring before.
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It's always a hiring problem in a start up, and you have to figure out, like, which one of
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those two states of the world you're
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One last point, Jammin, suggests that the one way to kind of realign incentives is to focus
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really more on sustainable growth rather than growth at all costs.
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In this really competitive funding market, do you think that that's a feasible way to
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approach, especially in the earlier stages?
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I just feel like the benchmark for success continues to raise and maybe arbitrarily for
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founders every quarter.
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So, I mean, we touched earlier to your point.
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I don't think there's any ICs or people are freaking out how do we take this wheelbarrow
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full of cash and get it out the door.
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But I do think there is, a business model element when you're a larger fund, which is you
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need to get the money to work in your best companies.
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Going back to the realm of theory, it is possible that a highly capital efficient
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company that, let's say, only raised $25,000,000 in venture capital became
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profitable and compounded for a really long time might not meet the capital deployment
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needs for a really large venture fund because they might say, yeah.
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I made 50 x my money, but I only had $10,000,000 in the company series a.
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So 50 x my money, it's half a $1,000,000,000, but I'm trying to return 10, $15,000,000,000 to
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my LPs.
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This sounds crazy to say.
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Half a $1,000,000,000 does not help.
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It doesn't help.
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And so I think it is very possible we're gonna end up in a world where there are capital
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efficient companies that end up raising the majority of their capital from smaller funds
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who don't have a capital deployment pressure, and there'll be ideas like LLMs and rockets and
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defense that are very capital intensive that will be the domain of funds who can put 100 of
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1,000,000 of dollars to work in a private company.
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And we're 10 x ing that 100 of 1,000,000 of dollars.
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This input to work would move the needle for them.
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I mean, you might end up in a world where, like, the source of your capital is gonna be a
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function of the nature of the business you're trying to build, and there'll be some ideas
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that just don't make sense for small funds.
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And there'll also be some company structures and types that don't make sense for big funds.
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I kinda feel like we're awfully close to that world right now.
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The next article is Hunter Walk's thought provoking blog post winning at seed isn't just
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about when to buy, but increasingly also when to sell.
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So Hunter discusses the evolving strategies in seed investing, suggesting that the traditional
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buy and hold approach may not always be the most effective.
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Instead, he highlights the inference of strategic exits to maximize returns.
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We talked about this last week with the essay from Sapphire Ventures.
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So we know that this concept of selling positions to return liquidity is important to
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LPs.
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One thing I've been thinking about, though, is that very few investors are spot on when it
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comes to making perfect investments at the right time.
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I feel like you can spend an entire career trying to do that, but even fewer will know the
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right moment to jump out of an investment.
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I actually wish that we had Hunter on this call right now because what I would wanna ask him
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is, okay.
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We need to start prioritizing secondaries or thinking about selling off positions.
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How do you even begin creating a thoughtful strategy around that as a seed investor?
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So it's funny.
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I had a conversation, I wanna say, 5 years ago with Jenny Lefkort at Freestyle and 2 years ago
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with Rebecca Caden and last year with Will Quist, all on this topic.
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And the interesting thing is a lot of people I've talked to, they just have some framework
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for selling.
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And those frameworks can be anytime a company hits x y z valuation, we try to sell 20%.
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Every round beyond round of a certain letter number, we're trying to be a net seller along
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the way.
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Any company that hits some other benchmark, we have a selling discipline.
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The goal is to get our cost basis.
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So I found the firms that are good at selling all have some kind of programmatic process in
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place that helps tell them when to sell.
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Because if you rely on emotion or feeling, I think that's why most VCs don't sell because
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the things you should sell are the things that are doing well and appreciating.
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And, you know, you talk to limited partners sometimes, they go, why don't you sell them?
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Or you go, well, the stuff I'd like to sell, there's no buyer for.
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And the stuff that I get calls for, I don't wanna sell.
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So here we are.
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And I will say this, almost every managing partner I know, regardless of fund sides, is
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thinking more about how to become more disciplined about secondary selling.
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And there's 2 things I think that are getting in the way of this.
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A few years ago, I wrote this blog post called, like, there's only 100 points of equity to go
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around, which is if everybody wants to buy more equity at a start up, eventually, you hit the
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absolute limit at a 100%.
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And the only way for this to work is early people have to sell to later people.
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And that is not something that's been institutionalized in venture the way it has
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been in private equity.
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And second, the stigma around selling needs to change.
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I think the latter has already happened.
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I would say many founders I know are secondary sellers in their own companies in the series b.
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I still think there's a stigma slash question around if you're a major investor who's on the
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board, who owns a big chunk of the company, I do think engaging in secondary transactions in
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the early stage of a company's life probably sends a signal you don't wanna send.
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If you're a small seed fund and you're selling alongside a founder in an organized
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transaction, I don't think that creates the stigma that it used to.
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The challenge is, like, figuring out how to have that conversation with the founder in a
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constructive way.
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But I think this liquidity pressure that LPs are feeling is real.
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I don't think hold periods for private companies are gonna come down because there's
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so much money in venture capital and private and private markets now.
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If you're a hot company like a Databricks or an OpenAI or you name your favorite top 10, if you
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want to remain private, you can take down 1,000,000,000 of dollars at a time, in some
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cases, several times a year to remain private, and you can do tender offers.
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You can give your employees and shareholders all of the features and benefits of being
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public, like the ability to transact in the stock, the ability to sell relatively frequent
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updates to price without actually having to go public.
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And I think for a lot of private companies, that's an attractive thing, and I'm very
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curious to see what the norms become.
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The fact that we don't have norms, we have sort of one off opportunistic, hey.
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We should probably sell.
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I'll be curious if we get to a place where it's normal at the series c that all of the early
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people are selling to the series c lead to enable that person to get the ownership they
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want and balance, find our dilution.
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And it just becomes customary that that's what early funds do, and I think the norms are the
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big thing.
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But a lot of fund managers, I think, for the first time are thinking about, well, what
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should our policy when we have our own policy, a precursor about how we think about
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secondaries and when to do it.
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And the biggest change I made after 21 was our policy used to be, oh, we're a default holder
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even in these later rounds, but we should have a conversation about selling.
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And now it's like, no.
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We're a default seller who can be topped into holding if selling is disruptive in some way,
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shape, or form.
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The final topic is the Menlo Ventures article titled the state of generative AI in the
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enterprise.
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It provides a detailed look at how generative AI is being adopted by enterprises,
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highlighting both opportunities and challenges.
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The piece emphasizes that while AI adoption is accelerating, enterprises are increasingly
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cautious about ROI and alignment with core business goals.
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This aligns with a recent TechCrunch piece noting that AI scaling laws are hitting
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diminishing returns.
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This may explain why enterprises are now focusing more on practical applications of
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generative AI rather than pushing boundaries of compute power.
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So in the article, it was revealed that companies are split in terms of buy versus
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build when it comes to AI solutions.
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So 47% of solutions are developed in house while 53% are sourced from vendors.
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This was a huge shift from 2023 when Menlo Ventures reported that 80% of enterprises
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relied on third party generative AI software.
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So in short, enterprises are feeling more confident in standing up their own AI tools.
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So if you're in 3rd party generative AI software company, what should be your focus in
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the next year, do you think?
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I think there's always this pendulum with new technology where a lot of times companies go,
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we don't understand that thing.
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Let's bring in Deloitte or AT Kearney or let's bring in a consultant to do a study for us.
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Then let's go buy a commercial off the shelf product and use it.
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And I think what's probably happening with AI is the engineers and teams at these companies
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are also tinkering and hacking on the side.
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And I'm sure now that they've been doing that for a year, they're like, oh, some of the
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things that these companies are selling us, like, we could do this ourselves.
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Like, we know how to use the open AI API.
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We know how to talk to anthropic, Mistral, llama, whatever it might be.
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Maybe we don't need to pay for this.
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Maybe we can do it ourselves.
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And if this follows the historical cycle, people buy stuff, then they go, we can do this
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in house.
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Then they build version 1.
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And then the work required to keep up with the rate of change and future requests makes people
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realize, while we could build this in house, it would be much better to buy a solution from
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somebody else who's gonna continue to stay on the cutting edge and is gonna build something
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that really works for us.
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I don't know how long it's gonna take to get back to that 3rd phase.
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The 3rd phase is usually as a software company where you make money because your customer has
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already gone on the journey of trying to do it themselves and has concluded either we can't or
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we don't wanna do that, and we're not going to.
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And I think that's the interesting thing.
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When I read it, though, there are so many interesting nuggets in this article.
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Like, a lot of this stuff, you know, I've I've been getting this drum internally that a lot of
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this stuff is experimental.
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It's not really production ready, and the article talks about how people are bumping into
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real issues and challenges, whether it's hallucination, cost, workflow.
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Rolling this stuff out at scale is not easy.
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So if I were a generative AI company, I would be trying to figure out what are the things
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that I can do as a specialist that my customer won't be able to do 6 to 12 months from now.
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And in some cases, that's just, like, deeper integrations.
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It's more workflow.
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It's more industry or problem domain specific technologies.
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It's a lot to do.
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But if I were a generative AI company, I would actually be excited that customers were trying
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to do this stuff on their own because the likely outcome is they won't be able to support
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the things they're building.
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And conversely, if your customers are able to build and support the thing that you were
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selling them on their own without much friction, I'd question the value in the problem
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you were solving.
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Like, I know a lot of companies that once upon a time built their own CRMs from scratch.
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They did.
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They're like, I can do this on my own, and then you're just like, oh, this is hard.
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Maybe we should just go buy HubSpot.
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Maybe we should just go buy Spot.
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Maybe we should just go buy Salesforce.
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Maybe we should just go buy a CRM product that, you know, has developers working on it every
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day trying to make it better rather than trying to support our own thing.
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The least surprising thing though was I can't imagine being a company who would go to their
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board of directors and say, we are spending no time whatsoever with AI.
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We don't care.
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It's not important.
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We're trying to get blamed.
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I don't think that's possible.
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So I think to me, it feels like we're still very much in the company's experimenting with
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where can we get real value.
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And maybe the era of let's play with AI because it's cool is turning into, like, let's figure
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out how AI can actually help us solve business problems and improve ROI.
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Well, we are all out of time for today.
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So thank you to our listeners for tuning in to this week's episode.
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Please like and subscribe and share, and we will talk with you all next week.
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Thank you.
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Bye.