Latest / The Learning Corner by Precursor / Episode #6: Pitchbook NVCA Venture Monitor Q3 2024 Report

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Episode #6: Pitchbook NVCA Venture Monitor Q3 2024 Report · The Learning Corner by Precursor

• 0:00
  There's almost no correlation at seed with unicorn picking.
• 0:03
  Unicorn picking is, like, actually pretty distributed at seed, which tells me that good
• 0:07
  companies come from everywhere, but most people are only gonna find a handful.
• 0:11
  I just worry about the out of favor thing, the non obvious thing, the thing that doesn't need
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  a lot of capital.
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  Who's gonna step in and fund that?
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  It's the week of October 28th.
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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 Farnam, and I'm joined by our GP and managing partner Charles Hudson.
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  This week, we're spending the entire episode diving into the q three twenty twenty four
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  pitch book NVCA venture monitor report that was just released.
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  The report outlines key highlights and statistics from across the investment landscape
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  and venture to provide a snapshot into where the industry has seen developments in the past
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  quarter.
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  And there's a lot of content in here, so let's get into it.
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  1st topic, the stalemate in deal making and fundraising.
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  So the report highlights that VC deal activity has pulled back significantly.
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  While the number of deals completed in q three reached 37100, it's still well below the highs
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  of 2021.
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  The overall deal value is projected to reach around a 175,200,000,000 for the year,
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  surpassing 2020 levels, but still far off the highs during the Zehrp era.
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  So, Charles, what's your take on this cautious investor behavior?
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  Are you seeing this shift towards quality over quantity and an increased focus on due
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  diligence, which is what the report mentions?
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  And how does that impact early stage investing?
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  That data pretty much matches what I've experienced, which is that there seems like
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  there's more money going to fewer companies, so definitely feels like quality over quantity.
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  Feels like more dollars concentrated in certain themes like AI that are just more popular with
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  investors right now.
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  And I think the other thing that you highlighted is I think investors feel like they
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  have more time to get to know companies.
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  I think there was a lot of, maybe you call it, drive by investing in 2021 where you meet
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  somebody and halfway through a Zoom, they tell you, hey.
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  I know I just met you, but I've got a term sheet.
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  I have to make a decision by the end of the day.
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  No.
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  I don't have time to meet with you.
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  No.
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  I don't have a data room.
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  And I think things have just slowed down.
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  And so the the amount of time you have as an investor now to get to know a founder, and more
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  importantly, I think, to get to know the business, it's just much greater.
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  I think it's healthier for all sides.
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  I think I've been doing lately with some companies who maybe in sort of the speed dating
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  era of investing, picked a partner who now that things are a little more challenging, maybe
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  they're realizing they're not as aligned as they thought they were.
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  This feels like a more normal investment pace, a more normal time on deal making.
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  It it feels weirdly, like, healthy.
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  Probably doesn't feel great if you're a founder, but from my side of the the table, it
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  feels like this is a more normal, healthy, sustainable pace.
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  To your earlier point, this could feel different for founders.
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  What are maybe some of the strategy shifts they should consider heading out into this
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  fundraising market?
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  You know, we track the time from sort of kickoff to close.
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  Conditional on success, it hasn't changed much.
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  It's been pretty steady over the life of the firm in about 3 months.
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  It's ticked up to closer to 4.
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  What I would say is for the companies in our portfolio that raise their experience isn't
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  that much different than it was before.
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  It's maybe an extra month or 2 of process work.
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  What I will tell people is I used to say, if you have 40 or 50 names in your funnel, the
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  probability that the person who's gonna do your round is on that list is high.
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  I think now I'm seeing people build investor lists of 75 to a 100 people per fundraise, and
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  the process of going out and talking to people and just sussing out who's interested is just
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  taking longer.
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  So what I would tell founders is, doesn't feel like the back end of the process has gotten
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  elongated.
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  It's really that front end discovery of who's interested in what you're building, who gets
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  you, who's got capital, and who's ready to invest.
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  That product seems like it's taking a lot longer for founders.
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  This space, to your point, is more the norm.
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  Obviously, no one wants to be dragged through a long and extensive diligence process, but there
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  are pros of that for the founder, wanting to make sure you have the right people on your cap
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  table and not rushing to just take capital for the people who are pushing it your way the
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  quickest.
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  I also just think we're getting to a point in this cycle where there will be almost nobody
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  whose last fundraising experience was SERP.
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  And I think in 2022 and 2023, you had people who are coming back to the market whose last
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  fundraise was sort of the GoGo, Zirp, COVID, Zoom era.
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  And they were sort of very surprised by the level of inquiry and the the style.
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  Now I think there's probably still some people who haven't raised since that era.
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  But I think even those folks know that the next raise will look and feel different.
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  Do you feel like second time founders, let's keep AI out of this, but but do you feel like
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  those types of founder profiles are exceptions to this, or do you feel like they're going
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  through these same trends as well?
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  I think most 2nd time founders are having a this could be a very specific answer.
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  They're having a harder time than 2nd time founders normally have, but they're having a
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  much easier time than your average first time founder.
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  And I think what's different is there have been times in my investing career where the bias
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  towards 2nd time founders is so great or repeat founders that if the idea is at all reasonable,
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  you just do it.
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  And the level of scrutiny applied to what they're building is much lower.
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  I found that there's more scrutiny applied to repeat and second time founders, and some of
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  those folks are having investors who backed them before say no, not because they don't
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  think the founders are great, but because there's something about the idea or the space
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  or the pitch that they don't like.
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  And I think a lot of people's experience as repeat founders has been once you've done it
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  once, you go back, you can kinda raise money for a ham sandwich, so to speak.
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  I don't think that's the environment we're in right now.
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  Moving on to the next topic within the report, it's the lack of distributions and its ripple
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  effects.
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  So one of the standout insights from the report is the lack of distributions back to LPs, which
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  has been almost as low as during the global financial crisis.
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  The cashback rate has been in the single digits for 8 consecutive quarters compared to the
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  16.8% average rate seen over the past decade.
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  This has obviously created a liquidity crunch that is pressuring VCs, and the lack of exits
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  is making LPs cautious about reinvesting in new funds.
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  We have talked a lot about this on the pod, so no need to belabor something we've already
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  delved into, but was curious to ask you what have been, if any, some shifts you've had to
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  make in your conversations with LPs in this time?
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  I think this is probably the central issue in venture right now.
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  You know, a lot of LPs I talked to say, hey.
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  We rely on distributions from you guys to fund the next fund.
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  So without distributions, our hands are tied no matter how much we love you.
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  And I don't think it's posturing a positioning.
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  I think it's it's real.
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  I think also this prolonged drought has reminded LPs that VC liquidity tends to come in
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  bunches, and I think they got used to something that felt more like peanut butter.
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  And so I'd say there's 2 big changes I'm seeing.
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  I'm talking to a lot of folks who are saying, how can we build out systems or programs where
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  we can provide more reliable, consistent liquidity to our LPs?
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  Because we think that's gonna be an important thing that will set us apart from other
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  managers.
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  I think they're right.
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  What I've been thinking about is the best way to increase the probability that you're gonna
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  have good numbers to show on the DPI front before you go back as an early stage fund is to
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  actually extend the time in between funds.
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  And so, you know, most of our life, we were raising a new fund every 2 years.
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  And in a world where LPs weren't particularly fixated on liquidity, that strategy worked
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  pretty well.
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  In a world where both liquidity and you couple that with slower time to graduate for
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  companies, you don't get as clear a picture in 2 years on a brand new fund as you used to.
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  So I think one solve is just take more time to deploy the fund.
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  Go back to what used to be the Northern Venture, 3, maybe even 4 years.
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  And if you do that, by the time you come back to market, you'll have more data on the
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  companies.
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  Also, we have a ton of really interesting companies that I saw a chart.
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  I think it was I don't remember who had made it, but Jason Lemkin had shared it.
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  Just showing a bunch of the most promising SaaS companies, like your stripes of the world
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  that'll go public.
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  Those companies are gonna be 15 or 16 years old by the time they go public if they go public on
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  the schedules that other people are forecasting.
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  But then you have to add in 6 months for a lockup if they go public, plus some kind of
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  orderly distribution.
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  So let's tack on another 12 to 24 months.
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  It might be 17 or 18 years before the funds that are in those companies, barring secondary
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  sales, are largely out of those positions or have sold down the public holdings to a place
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  where they're comfortable.
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  That's, like, double the fun life that's on the cover for most funds.
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  That's really different.
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  Now look, my my hope slash expectation is the magnitude of those distributions from the
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  winners will make LPs say it was worth it in the end.
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  I got distributed out companies that were worth 50 to a $100,000,000,000 when they went public,
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  and maybe they go up from there.
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  I hope it's worth it, and I believe it will be.
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  Are there any things that maybe funds 1, 2, 3, and even 4 that you kind of were like, we don't
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  need that, that now looking ahead, fund 5 and beyond, you're like, oh, LPs are asking for
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  this.
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  Maybe I should have it.
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  I think for our first few funds, I'd say most of our LPs, not all of them, but many of them
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  were like, you should just hold everything to maturity.
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  Like, you should just maximize.
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  And they're like, look at the small fund.
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  You know, holding things to maturity could really spin the multiple on you.
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  And if you get you to a place that's, like, very attractive.
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  Also, we didn't have very many big checks in fund 1.
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  So most people were like, the amount of money I've given you, I'd rather get back a big
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  multiple of it later than a little along the way.
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  The newer funds are bigger, and the checks that people wrote are larger.
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  And I think in general, LP's liquidity preferences for money now versus money later
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  have shifted.
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  And I think the challenging thing as a fund manager, is this a permanent shift?
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  Is this a forever shift where LPs are gonna just want more money sooner?
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  And you think, who wouldn't want money sooner?
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  I'd argue the person who wants the most money later, maybe doesn't want money sooner.
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  And second, if it's not a permanent shift, how long will we be in this era?
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  I think it's very possible that if we have, in the back half of this decade, a big IPO hall,
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  people might go back to saying, like, venture's great because it compounds for a long time.
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  Look how great it was that these companies stayed private for 15 years, the same ones that
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  people are complaining about that won't go private today.
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  We operate on a 10 to 15 year cycle.
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  And so I'm always asking myself, are we gonna make a decision right now in this moment that
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  makes sense today that we will deeply regret 5 years from now.
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  And I think on the way up, my feeling was selling out of some of the companies that are
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  ramping is gonna hurt our relative returns because the people who hold those companies and
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  stay in them are gonna have better returns.
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  And I'd say probably one of the biggest evolutions I've had since I started the firm is
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  the balance between absolute performance and relative performance.
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  And I think the 2019 to 2022 era was a lot about relative performance.
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  I got a lot of people saying 5 x is the new 3 x.
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  But if
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  you're just like, hey.
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  I know that I'm competing against crypto.
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  I'm competing against people who have funds that are really ramping, like, 3 x suddenly
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  didn't feel that impressive.
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  And so I think keeping some balance between an absolute basis doing a 3 x fund in any almost
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  any environment puts you in the winner's circle versus worrying about what does top quartile
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  unrealized performance look like this quarter.
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  I think I've I've shifted over time to focus more on how do we just focus on absolute
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  performance.
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  The chips on relative will follow where they will.
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  But if we focus on absolute performance, we'll probably make better
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  interim decisions too.
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  Moving on to topic 3 for the report, fundraising challenges.
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  It's a good leeway into what we were just speaking about.
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  Another key insight is that 80% of the capital raised so far in 2024 has gone to established
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  fund managers with smaller or newer funds struggling to raise capital in the current
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  environment.
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  This is largely due to, again, LPs being cautious with reinvestment and preferring these
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  more established managers as they wait for the liquidity crisis to ease.
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  So we touched on this actually last week quite briefly, but how do you think this
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  concentration of fundraising in a few hands will impact the venture landscape in the next
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  couple of years?
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  I think when more people have money, you get a wider variety of ideas.
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  I probably never told you this.
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  Probably 5 years ago, I was talking to someone who's like, there's too much money in venture.
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  And I was like, no.
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  There isn't.
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  There's too much concentration in venture.
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  And he's like, what do you mean?
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  I go, well, look.
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  Imagine a world in which one venture firm had all of the money in our industry.
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  You would only get the companies that that one fund thought were interesting.
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  Now if that fund had, like, perfect excellent judgment, it wouldn't matter, but no fund does.
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  Now if you take it to the extreme, imagine, like, every venture firm had a dollar.
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  You'd get, like, the wildest set of ideas.
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  So I think there's some optimal distribution on there where I think you need concentrated large
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  funds to fund things like LLMs and to fund space and to fund some of the expensive defense
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  tech.
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  So there's absolutely a role for big funds in venture.
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  But I think the beautiful thing you get when you have many small funds is you get people
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  with different points of view, different networks, different interests funding, like,
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  their own version of the future.
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  And I think it was maybe Sapphire or maybe it was Sandana.
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  Someone published something that basically said there's almost no correlation at, like, seed
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  with unicorn picking.
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  Like, unicorn picking is, like, actually pretty distributed at seed, which tells me that good
• 13:00
  companies come from everywhere, but most people are only gonna find a handful.
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  I think it's really interesting, and so I think it's gonna have impacts on what gets funded
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  because more of the dollars are gonna follow the interests of the big firms.
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  And, look, those firms are very good at what they do, and they will pick the things.
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  I just worry about the out of favor thing, the non obvious thing, the thing that doesn't need
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  a lot of capital.
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  Who's gonna step in and fund that?
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  And I also have just talked to a few emerging managers who are just like, is this the new
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  business?
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  Is the new business basically a very small handful of big firms with 80% of the dollars,
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  and the remaining 20% of the dollars goes to quasi established emerging managers or emerged
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  but not established managers.
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  And those folks have to decide how much of their investing should be influenced by the
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  preferences of big funds.
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  The positive case is this is cyclical, and that as LPs get more distributions and the risky
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  nature of venture feels good, that they will sort of pivot back to small funds.
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  I think the bear case is a lot of these LPs were structurally capped at how much money they
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  could put into the very big funds that they wanted to get into.
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  And those funds are now 2 to 10 times bigger than they used to be.
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  And so if you really want to put money into one of those big franchise funds and you were
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  capped, you might now be in a position where you can put more money in.
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  And you might just say, you know, if my choice is double down on a big established fund that
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  I've done the underwriting on and that I believe in, or stay flat with that fund and do
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  the work of meeting new managers, I think some people are gonna just say, shouldn't I just
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  give more of the might of the big funds?
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  There is a subset of LPs regardless of all the data points that you gave and the arguments for
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  distributing dollars to more fund managers who just believe that the bigger, more established
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  funds get to see everything, and they only wanna invest with those types of funds.
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  How do you respond to that, and when do you know when not to place any effort in those
• 14:44
  discussions to chart forward with those relationships?
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  I've met some people, particularly on the pension side, who need to put 100 of 1,000,000
• 14:51
  of dollars to work per year in privates.
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  I have a very hard time arguing with those people that they should spend the underwriting
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  cycles to write a $3,000,000 check.
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  And it turns out they agree with me.
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  So those conversations are pretty easy.
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  I think what's likely to happen is there's gonna be an LP base for smaller emerging
• 15:08
  managers that might be more family office, fund to funds, small endowment, and that more of the
• 15:15
  big dollars are gonna go to the big platforms.
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  I often talk to LPs about this very topic and ask them, you know, one one of these I often
• 15:23
  ask people is, like, tell me about your venture program.
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  If someone says we have a very mature or established program, that tells me they're
• 15:29
  probably in Sequoia Founders Fund.
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  They're in a bunch of really good managers who've done very well for them, and they they
• 15:34
  don't necessarily feel the need to add more.
• 15:37
  And to their credit, I think the big funds have done a better job in the last few years of
• 15:42
  covering more of the ecosystem.
• 15:45
  I think all the really good firms I know are like, well, we're not gonna just wait for the
• 15:48
  great series a companies to find us.
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  We're gonna go find them at seed.
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  We're gonna go try to find them when they're leaving their job.
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  We're gonna work harder.
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  And, ironically, I think it's because if you think about it, it's sort of like great powers
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  competition.
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  Those firms are not competing with precursor.
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  Those firms are competing with each other.
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  And I think those firms are trying to figure out, you know, how do I beat the other, mostly,
• 16:07
  dozen firms in my peer set?
• 16:09
  We're all gonna fight over kinda the same companies, mostly repeat founders, a lot of
• 16:14
  high profile.
• 16:14
  Like, we're gonna fight over the same pool.
• 16:16
  So how do we win more of this?
• 16:18
  And I think it is zero sum competition for them.
• 16:21
  And I think all the people I know with those big funds would describe it as such.
• 16:24
  Like, if there's a deal we want and someone else gets it, we lost.
• 16:27
  There may not be an equivalent quality deal that comes through our office again this year.
• 16:31
  And they think of it as it does feel a lot like geopolitical rivalry.
• 16:35
  There's gonna be something to be learned there.
• 16:36
  Whereas I think for seed, it's really about, can you find things that will be consensus good
• 16:41
  in the future, but are not consensus good today?
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  And I think there was a period of time where as a seed manager, you could also do consensus
• 16:48
  good today deals as 25 to 50% of your diet, and I don't think that's true anymore.
• 16:53
  A lot of people have told me, please don't say that or I disagree with you, and they're
• 16:56
  entitled to their opinion.
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  I just think the big multistage funds have gotten good at sussing out the consensus
• 17:01
  obvious good seed deals.
• 17:03
  They're gonna compete for those deals, and they're gonna win a lot of them.
• 17:05
  Not all of them, but they win a lot of them.
• 17:06
  So in some ways, seed is back to the basics of the job.
• 17:09
  Can you find things that other people don't understand or don't believe in yet and be
• 17:13
  right?
• 17:14
  We're going back to, like, what the whole reason, like, that seed needed to exist was
• 17:17
  there were companies that the big funds, like, they didn't know what to do with them in their
• 17:21
  current state.
• 17:22
  I think we're just going back to that, and that makes me really happy.
• 17:24
  It's a good test on fund managers too of, like, did you go into this with a very unique idea on
• 17:30
  how to drive capital into the market?
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  Or are you more in the consensus side and trying to aspire to pile into deals that
• 17:37
  probably you won't be able to compete in on price?
• 17:39
  Well, this is great.
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  We are all out of time today.
• 17:42
  Thank you, Charles, for jumping in.
• 17:43
  Thank you to our listeners.
• 17:45
  Please like, subscribe, and share with friends, and we will see you next week.
• 17:49
  Bye.