Latest / The Learning Corner by Precursor / Episode #4: David Clark from VenCap International, Continuation Funds by TechCrunch, Neal Sarraf from Forum Ventures

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Episode #4: David Clark from VenCap International, Continuation Funds by TechCrunch, Neal Sarraf from Forum Ventures · The Learning Corner by Precursor

• 0:00
  I don't think you can flog a company into greatness.
• 0:03
  If somebody's working on an idea that it turns out is not VentureScale, yelling at the person,
• 0:08
  applying more pressure, it doesn't actually change the nature of the opportunity in front
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  of them.
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  It's the week of October 14th.
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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 team's attention over the past
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  week.
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  We've got a lot to talk about, so let's jump into it.
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  Topic number 1, what should investors expect from the VC industry over the next 3 to 5
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  years?
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  It's a LinkedIn post by David Clark, CIO of Venkat International, and the LinkedIn post
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  elaborates on views that Rickzilla from Equal Ventures shared on x.
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  Both investors highlighted the increasing divergence predicted in VC fund performance
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  over the next 3 to 5 years, something expected during economic downturns.
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  Clark drew parallels to the venture correction that occurred following the 2,008 crisis, and
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  how it was the top tier funds who dramatically outperformed the rest of their peers.
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  He then goes on to share that this stellar performance was largely driven by three
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  factors.
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  1, backing a few high quality companies, 2, having capital availability, and 3, having the
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  ability to reinvest in tough times.
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  Clark argues that it's more important than ever for LPs to have exposure to the small amount of
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  winners that drive DC performance, while also calling out the fact that corrections are a
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  feature, not a bug, in venture capital as a cyclical asset class.
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  I think all of these thoughts are valid and make logical sense, but Charles, how do you
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  think the concentration of capital among top tier VCs actually impacts innovation and
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  competition in the startup ecosystem?
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  I've really enjoyed his writing.
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  I think there's a bunch of other things he's brought up where people said small funds always
• 2:02
  outperform.
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  And if you wanna go down that rabbit hole, I would encourage you to read his writing.
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  I think it's some of the more thoughtful analytical work in that subject.
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  I've talked about this with a team a lot that I think this concentration of capital in big
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  firms has many consequences.
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  The majority of which I think won't be fully visible for years.
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  So I think if I were to take the bull case of this is how you do it, you look at a company
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  like OpenAI.
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  It's a very expensive company to build.
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  It started life as an expensive company and has remained an expensive company.
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  And truthfully, the only funds that can really afford to underwrite and invest in a company
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  like that are people who have big capital stacks because it it just the amount of capital
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  required to build that company is something that only a select number of funds can afford
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  and have the business model to do.
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  Also, if you believe that large stable funds will attract repeat founders, and if you
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  believe that repeat founders are statistically more likely to be the one to produce the big
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  outcomes, what you would say is in a time of capital scarcity, there will be a flight to
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  quality, both by limited partners, but maybe even more importantly by the folks who take
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  their capital, the entrepreneurs.
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  They'll say, I wanna work with the big established funds because I know that they'll
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  have capital too.
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  I think there's probably some truth that there's a certain class of ideas that can only
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  be funded by VCs who can both write a big initial check and continue to write significant
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  checks through life of the company.
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  I don't think that applies for every idea.
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  If you're doing defense tech, if you're doing space tech, deep tech, hard tech.
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  I do think a large balance sheet is important.
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  I can think of lots of other software companies where that was not a necessary condition.
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  I also just think we live in a world where if enough LPs believe that only the biggest firms
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  will have access to the best entrepreneurs for the next window of time and that bigness is a
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  feature and useful, then all the money will go to those funds and it will become the self
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  fulfilling prophecy.
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  And I don't know.
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  I'm of the mind that we're moving towards a world where there are certain types of
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  businesses that only big funds can fund.
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  And if those businesses turn out to be multi tens of 1,000,000,000 or 100 of 1,000,000,000
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  of dollar scale outcomes, all of that money will find a good home.
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  If it turns out that the thing that matters most is the scale of the idea, not the scale of
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  the capital put behind it, it's very possible that these will end up being very expensive,
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  behind it.
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  It's very possible that these will end up being very expensive experiments that don't work out.
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  But if you look at how valuable some of these companies are, like, if you're in that peer set
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  of big funds, it's hard to keep up if you're not in the top ten companies.
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  I think we're coming back to as people say, Ventures Power Law.
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  And, yes, the Power Law really has two meanings.
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  Like, one is a very small proportion of the outcomes drives the majority of the returns.
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  I think everybody understands that.
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  But perhaps the more important piece is that the scale of the winners is what really
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  matters.
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  So it's not just that a very small sliver of companies matter.
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  It's the scale of that really small sliver of companies that really matters and determines
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  how successful you'll be, and I think it's very hard to have a top fund if you're not in those
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  companies.
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  In a time where LPs are just trying to snag whatever allocation they can in in some of the
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  more established funds, I think that's a reality.
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  What are the strategies that not even just emerging funds, but anything that's not a
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  multistate, multibillion dollar fund can employ to weather those economic downturns and also
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  deliver strong returns?
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  If you're not a multistage, multibillion dollar fund, if you see one of those competing for a
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  same deal that you're looking at, do you just go running?
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  How do you remain competitive there if that's what some LPs believe?
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  It's interesting.
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  I just came from the emerging manager circle that the EcoFentures guys put on.
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  I told some folks at the event this.
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  I think that the era of seed that we were in for the 1st 20 to 25 years of seed investing,
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  it's essentially over, and I would characterize that era as one where the big multistage funds
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  left seed to seed funds.
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  It's that this is your thing, like, we're busy trying to help companies scale and go public.
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  We don't need to be in this business.
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  You guys are our partners and friends.
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  You will route the best companies to us.
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  I think most of the multistage funds at this point are like, we need to have a product in
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  every category, see it as a category, and we think, a, we're good at this, and b, we don't
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  wanna just see what's a really good money making opportunity to these people who are our
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  partners and friends.
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  We don't wanna put them out of business either, but we're gonna have our own footprint, our own
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  shingle, whatever analogy you wanna use.
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  We're going to participate in this market, and we're gonna also take companies that come from
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  seed managers, but we're gonna see them ourselves too.
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  I think there's so many times when I meet companies and I talk to people at multistage
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  funds and they go, this founder profile doesn't fit what we're looking for.
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  Or the stated size of this opportunity doesn't feel like it's a multibillion dollar outcome
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  that we need to fulfill our fund.
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  So I think where you see the rubber hitting the road already is repeat founders.
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  I think there's a ton of repeat founders I meet who, 10 years ago, probably would have gone to
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  a multistage seed fund, probably were less willing to take on any signaling risk.
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  A lot of the repeat founders I talked to today are like, I want money from a multistage fund.
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  I understand the deal I'm making that we'll either clear their series a bar or we won't.
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  If we don't clear it, it's not as if I would have cleared it at another firm of equal
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  caliber.
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  It means we just didn't execute enough, and those multistage funds can pay higher prices.
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  So I think we're gonna go back to a world that will be multistage type of seed deals, which is
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  gonna be mostly high profile people when the the next person leaves OpenAI.
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  They're not gonna come to Precursor because they're gonna go raise $50,000,000 on some
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  really high valuation to go build something that leverages what they did at OpenAI.
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  And there's a very small sliver of funds for whom that entry point and that deal structure
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  makes sense.
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  And we're not one of them.
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  And then I think we're gonna have a a whole other seed ecosystem, which is gonna be back to
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  basics.
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  It's gonna be people where there's just less data about these people, and where the initial
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  fundraise ask is more modest, and where maybe the sort of path to victory for that company
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  isn't as clear.
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  And I think seed managers can do very well backing those people.
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  But I think we're we're gonna continue to see this evolution of seed.
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  As the multistage funds, I think, there are permanent presence in our category now.
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  They're not going anywhere.
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  It's a good tail actually into the second topic.
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  Speaking of new products that larger funds can create and different vehicles to deploy, GC is
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  working on a continuation fund worth up to $1,000,000,000 It was released by TechCrunch.
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  For those who are unfamiliar, these funds allow VCs to keep managing stakes in their successful
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  portfolio companies rather than selling them outright.
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  It's a move that's gaining traction in venture capital, especially with this current slowdown
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  in IPO's and m and a activity.
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  So investors in GC's previous funds will have the option to either cash out or roll their
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  stakes into the continuation fund, keeping exposure to potential future growth.
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  This strategy benefits VCs by maintaining long term relationships with portfolio companies and
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  avoiding cap table disruptions.
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  However, it also presents a trade off for limited partners as shares sold in secondary
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  markets oftentimes come at a discount.
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  So given the recent popularity of continuation funds in VC, how do you think this trend might
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  affect a larger ecosystem?
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  One of our portfolio companies, Jeff, who runs a company called Tap, he and I, 2 years ago, he
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  bought up continuation funds, and I was like, I don't know.
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  This is a PE thing.
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  This is, like, not coming for venture.
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  I don't know.
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  Like, people are starting to talk about it.
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  This is have you thought about it for precursor?
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  And I said, let's just turns out you should listen to founders.
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  This is one of those topics that went from something I feel like very few people in
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  venture were talking about continuation funds 2 years ago.
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  Last year, I started hearing rumblings that some of the bigger funds were gonna do them.
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  And this year, I don't know a single panel or conference I've gone to where strip sale
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  continuation vehicles, some liquidity vehicle for LPs hasn't come up as a significant
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  conversation topic.
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  And I think it's largely driven by the fact that, like, the principal sources through which
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  limited partners get liquidity are IPOs and m and a, both of which are at record lows.
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  And neither of which really show any, as far as I can tell, sign that they are likely to bounce
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  back in a meaningful strong way.
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  And as we talked about as a team, a lot of limited partners, this is a self filling
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  program.
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  We take the proceeds, and we put them back to work into the next funds.
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  And when those proceeds come back and for the last few years, this one of my friends said,
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  distributions have been delayed.
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  These delayed distributions are creating all this tension.
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  And so you would think, what are your solutions as a GP?
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  One solution is you go out and you sell the position.
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  You go take all the shares, and if you can find a secondary buyer, but then you're giving up
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  all the future upside.
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  But you're producing liquidity for your LPs.
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  The configuration vehicle has this, like, nice characteristic where you're selling the
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  security to a new vehicle where the clock can start over.
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  And if you're an LP who wants to stay in this position, you can roll with it.
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  If you're someone who wants or needs the money back, it gives you a way out.
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  Now when we talked to those at the retreat with with our CFO, these things are incredibly
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  complicated to price.
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  You have to go raise capital for them.
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  They're complicated.
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  But if you look at the names that GC mentioned, I think it was Stripe and Gusto.
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  These are good private companies that are not public yet and will be public someday.
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  But as far as I can tell, it won't be tomorrow.
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  And so I think as long as the m and a and IPO windows remain challenging for venture backed
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  companies, I think there's gonna be more and more pressure on GPs to find creative ways.
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  I don't know what it's gonna take to reignite the IPO market's enthusiasm for tech stocks.
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  And some of the m and a overhang is clearly regulatory, but not all of it.
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  I don't think regulatory explains everything.
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  And without favorable exit environments, I think GPs are gonna look for things like
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  continuation vehicles and strip sales and other vehicles to to get money back to LPs because
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  our business is returning money to
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  multistage, multibillion dollar funds that will be able to pull together these continuation
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  funds and market them to their LPs?
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  Or do you think that basically anyone, if you have a sub $100,000,000 fund, if you had a
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  couple bets, you could lobby and successfully get a continuation vehicle going.
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  I think the challenge is, like, 2 things.
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  Do you have positions that are big enough to make the exercise worth it?
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  And for a lot of smaller funds, even unless you're owning, like, 10% of Databricks or
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  something like that, the value of the position might not be big enough to warrant the level of
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  effort required to do this.
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  I think this is another place where, like, big funds and small funds are just in a different
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  universe.
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  For a $100,000,000 fund, a $25,000,000 position in a winning company might be a material chunk
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  of your funds NAV, but probably isn't anywhere close to big enough to warrant spinning up the
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  CV.
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  My hunch is for most smaller funds, the right answer is to do direct secondaries.
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  So take your winning positions, find a way to sell them directly, return that cash to your
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  LPs.
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  Yes, you are giving up the future upside that you would get if you could continue to hold it
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  in some kind of vehicle, but you're solving for the near term cash needs by selling those
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  positions.
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  And who knows?
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  You might, 5 years from now, say, gosh, I sold it a 1,000,000,000 and it went to 50.
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  Or you might say I sold it a 1,000,000,000 and it went to 50¢.
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  But I think for most small funds, you probably don't have enough premium assets at a high
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  enough mark to bundle them together and do this.
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  And we did talk about this at length with our CFO, and there was at least a handful of slides
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  that outlined what are the decisions you have to consider in order to bring one to life.
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  So I'm curious to see how it all unfold.
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  Moving into the last topic, real talk between founder and VC over the years.
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  I giggled at this one.
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  It was a post published by Neil, managing director at Forum Ventures, that attempted to
• 13:06
  sum up the discussions and interactions between VCs and
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  founders in the peaks of 21
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  and then more in VCs and founders in the peaks of 21 and then more turbulent times in the past
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  3 years.
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  The post is super brief, so I can basically recite it.
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  It starts out with a VC in 2021 saying, growth is all that matters.
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  And then you've got the founder replying, cool.
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  I'm gonna stay focused on my customers.
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  The VC then comes back in 2022 and says, glad you're growing, but efficiency matters more
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  now.
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  The founder replies, cool.
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  I'm going to stay focused on my customers.
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  VC in 2024 and beyond comes back and says, do you have a path to profitability?
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  And the founder in 2024 and beyond says, cool.
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  I am going to stay focused on my customers.
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  And so the takeaway here is that while capital markets have changed, so did VC advice, but
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  staying focused on customers stayed consistent from the vantage point of the founders.
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  And Neil said, oftentimes, they know their business best and can steer the ship there.
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  So, of course, this was a really fun summary, but I would love to know what you felt could
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  have been inserted here either on the side of the founder or investor.
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  I read this, and I I cackled.
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  I didn't even giggle.
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  I cackled.
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  I thought it was so funny because it's so true.
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  I spent a lot of time talking to founders.
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  We do these monthly 1 on ones with them.
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  A lot of times, one of the last questions they'll ask me is what's happening in the
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  fundraising environment?
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  I'm like, the last year I've been like, are you an enterprise AI company?
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  If so, you will have a lot of interest.
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  If not, like, godspeed, it's gonna be hard.
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  And what I tell people is the more dependent you are on the fundraising markets, the more
• 14:34
  you have to actually care what they value.
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  And so if you're a company that, like, doesn't need to raise venture capital, either because
• 14:40
  you're profitable or because you've got a big war chest or for whatever reason, the founder
• 14:46
  in this statement did the right thing, which is just to ignore all of that because it's just
• 14:49
  noise.
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  But most of the people we work with, they need to raise.
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  And I think the challenge is sometimes people are out of step with what the market wants.
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  I remember there was a period of time where all of a sudden, all of my friends who do consumer
• 15:01
  seeds and series a's were like, we're not doing any more consumer companies that don't have
• 15:04
  revenue.
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  And a bunch of the founders were like, but I was like, I'm sorry.
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  The rules have changed.
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  You got no warning.
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  I know this feels horribly unfair, but this is how the business works.
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  And so I think as a founder, you have to decide what kind of business do you wanna build.
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  And we have a bunch of companies that were profitable when growth was the thing, and
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  nobody was interested in those businesses because they weren't growing enough.
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  And I think those founders were extremely frustrated in the moment that nobody cared
• 15:28
  about their beautiful profitable businesses.
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  And then profitability became in vogue, and everybody wanted to talk to them.
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  And they were like, oh, wow.
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  That changed overnight.
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  I tell people 2 things.
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  1 is, if you ever have a conflict between what you should do and the choices are this is good
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  for the business and this is good for a potential fundraise, Choose the thing that's
• 15:45
  good for your business because you probably don't actually really know what VCs are looking
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  for.
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  And if you optimize for what you think they're looking for and you're wrong, you lost the
• 15:53
  chance to make your business better and you shot for a target that wasn't real.
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  And the second thing is you should evaluate how dependent you want your business to be on
• 16:01
  future venture capital.
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  You can't change the money you've already raised, but you can decide, hey, I don't wanna
• 16:06
  run a business that's subject to the whims of these couple thousand people and what they run
• 16:10
  on x or what their LPs have told them or whatever's happening in their firms.
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  I wanna be independent.
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  That's harder to do, but not impossible.
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  We've lived through all of those worlds.
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  We live through the spend $10 to generate $1 in revenue if you have to because growth is all
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  that mattered.
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  And then I was like, woah.
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  Everybody should stop doing that.
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  We're all about efficiency and burn ratio, and we're gonna talk math.
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  And then last year, everyone was like, oh, should I, like, stick AI in my pitch deck?
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  It used to be what you guys wanna hear.
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  I'm like, does AI matter for your product?
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  People were like, no.
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  I'm like, then don't put it in your pitch deck.
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  And I think this is an unbelievably difficult time to be a founder because it feels like
• 16:43
  between COVID and SERP, it changed change in interest rates and compression of public
• 16:46
  company multiples.
• 16:47
  These founders live through what normally takes a decade to play out has been compressed until
• 16:51
  2 and a half or 3 years.
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  And I'm sure it feels like whiplash, and I wish I could tell them it will get better and get
• 16:56
  different.
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  I can't tell them that it did catch us.
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  It feeds into an existential question I have about venture from the investor side.
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  I found that throughout some of the more turbulent times, I witnessed a lot of investors
• 17:08
  give really either wish washy or straight up bad advice to founders as a mechanism to push
• 17:14
  their own interest and assuage some of their anxiety about the broader market.
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  And, obviously, it's inherent to the job of an investor to act in the fiduciary interests of
• 17:23
  our LPs, but I'm curious if, one, you also encountered this behavior.
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  And, 2, how do you strike this balance of being a true partner with all of our founders while
• 17:33
  also guiding returns driven counsel?
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  I can tell you what doesn't work.
• 17:37
  Go into a board meeting saying we need to grow revenue and cut the burn.
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  I used to think that was like a joke.
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  I actually was in a board meeting where someone came in and said, we've got to grow revenue and
• 17:45
  cut burn.
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  I was like, you did it.
• 17:47
  You said the thing.
• 17:48
  So I I do think that makes it hard when you tell people to do things that are
• 17:52
  unambiguously, obviously good, but hard to do.
• 17:55
  I always try to tell people when we have this conversation, what kind of company do you wanna
• 17:59
  build?
• 17:59
  And what is your risk tolerance?
• 18:01
  We have some founders in our portfolio who I think, like, truly are gamblers.
• 18:05
  They will do a low probability, high upside activity because that's just how they're wired,
• 18:10
  and it's not scary for them.
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  We have other people who are very conservative.
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  So I think first, you have to know who the person is that you're talking to.
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  And second, I don't think you can, like, flog a company into greatness.
• 18:21
  If somebody's working on an idea that it turns out is not venture scale, yelling at the
• 18:25
  person, applying more pressure, it doesn't actually change the nature of the opportunity
• 18:30
  in front of them.
• 18:31
  So I like the way you ask this question, Mia, because I always try to ask myself the
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  following.
• 18:35
  What is the real opportunity that we're going after with this company now that with each
• 18:40
  successive month board meeting year, we've peeled back more layers of the onion?
• 18:44
  If anything, we should have a clearer picture about whether or not this is a big company.
• 18:49
  And I feel like the best thing I can do for the human beings running the company and for our
• 18:54
  fund is actually to make sure that we're aligned on that.
• 18:56
  Answer.
• 18:57
  Because if the company really is a slow growth company that probably isn't gonna be a venture
• 19:02
  scale outcome, I've told people, I was like, this isn't gonna be one of those.
• 19:05
  So what do you wanna do?
• 19:06
  And we had a founder's, I like running this business.
• 19:08
  I want to continue to run it.
• 19:10
  And I was like, okay.
• 19:11
  Then the advice I'm gonna give you is the advice I would give to somebody who was running
• 19:15
  a slow growth business, which is probably we should get profitable.
• 19:17
  And then we should try to figure out, like, what exit opportunities are, if any.
• 19:20
  And maybe there's a mechanism through which you buy us out.
• 19:23
  We've had companies actually buy the preferred shareholders off the cap table so that they
• 19:27
  could run it in the way that they see fit.
• 19:29
  And those were not companies that I think aspire to be at your scale companies.
• 19:32
  And I think the problem is what you hinted at is sometimes people are like, I need this
• 19:35
  company to be successful for my career, for my promotion, or I need this company that exit for
• 19:40
  a 1,000,000,000.
• 19:40
  I'm like, we're not going after an opportunity that's gonna yield that.
• 19:43
  And and the question is, like, how do you self regulate?
• 19:45
  When you find yourself in a company where you're like, oh, this one isn't gonna be what I
• 19:50
  thought it was gonna be.
• 19:50
  This one isn't gonna be what I told my LPs it was gonna be.
• 19:53
  For some people, the natural tendency is to get frustrated with the company and take it out on
• 19:57
  the company.
• 19:57
  And I'm just like, oh, that's probably the wrong instinct, but I understand where it comes
• 20:01
  from.
• 20:01
  Or it's just deliver information without contact.
• 20:04
  That's all of the companies in our portfolio have to get profitable.
• 20:06
  I'm like, this is a company that's burning $2,000,000 a month.
• 20:09
  Why don't we start with, like, getting the burn rate down?
• 20:11
  Maybe we start there.
• 20:13
  And so I always think the founder job is so hard.
• 20:16
  I know very few founders who sit around doing nothing all day.
• 20:19
  Most of them are working as hard as they can to make the company as successful as they can.
• 20:23
  And so I always ask myself, what's the probability that the thing I'm going to mention
• 20:26
  to this founder isn't something that they've thought of already?
• 20:29
  If you put the people who run the company first and you think about them as human beings and
• 20:33
  you ask yourself, what am I asking these people to do?
• 20:36
  What are they capable of doing?
• 20:37
  I find you would generally end up in the right place.
• 20:39
  There have been a few times I think I felt conflict.
• 20:41
  I'm like, oh, we need to find a way to maximize the money we can get back from this company.
• 20:46
  And that might involve selling it and asking the founder to go work in a place where they're
• 20:49
  not excited to work.
• 20:50
  It's my job to explain to the founder why I think this is an important thing to do, and I
• 20:54
  take that seriously.
• 20:55
  If we do our job right, the number of times where there's a conflict between what's best
• 20:58
  for us and best for the founder, it's not 0, but it should be very small.
• 21:02
  We are all out of time today.
• 21:05
  Thank you, Charles, for jumping in, and then thank you for all of our listeners for tuning
• 21:10
  in.
• 21:10
  Subscribe and share with your friends, and we will see you next week.