Episode #18: Founders Quitting vs Stopping, The Rise of Spinout VC Funds, AngelList State of Venture Report

What I've learned is as an investor, sometimes the best thing you can do is to open the door to a conversation about what the future might look like and create space for the founder to know that you're open to that idea.

It's the week of February 3rd. Welcome to the Learning Corner, a Precursor Ventures podcast.

Welcome to the Learning Corner by Precursor. I'm Mia Farnam and I'm joined by our GP and managing partner Charles Hudson, where we will be talking through the articles and Goodreads that that caught our team's attention over the past week. The first essay is by our good friend Hunter Walk, titled I Never Want Founders to Quit, But Sometimes they Should Stop. Here, Hunter raises a nuanced take on founder perseverance. One of the prevailing blanket beliefs in venture and Silicon Valley could be that resilience is everything. Never give up, push through the downturns, pivot when necessary. But Hunter poses the question of what what happens when that mentality leads founders to chase an impossible outcome? He argues that the best founders recognize when to pivot, but also when to step away entirely. Hunter makes a distinction between quitting and stopping, one being reactive, the other being a more strategic decision. Oftentimes, it's probably investors who have to have these really difficult conversations with founders. So, Charles, how can you frame that conversation in a way that's constructive rather than shocking and demoralizing?

I will say, Mia, this is one of those things I think you get better at with practice. This is an awkward conversation. I can tell you the way I think about these. The most important thing that I believe is I don't think I can tell a founder to quit or to stop. It's their decision. If they want to keep working on the business, it's really up to them. But what I've learned is as an investor, sometimes the best thing you can do is to open the door to a conversation about what the future might look like and create space for the founder to know that you're open to that idea. I've handled some of these poorly in the past where I've told someone, I think you should shut this thing down and quit. And they were just like, crushed. Like, you don't believe in me. I'm like, no, that's not what I intend. I can see how you would draw that conclusion from the poor way I handled this. But that wasn't my intention. My intention was to let you know. So now oftentimes what I tell founders, you don't owe me anything more. In this business, at this point, you've given it your all, you've tried really hard, you've sacrificed for years. If this is something that you want to continue to pursue because you find it personally interesting and satisfying, you should continue to do so. If this is something you're pursuing because you have a dogged determination to return investor capital or because you just don't know how to quit, that is not a good reason, in my opinion, to quit, to keep going. And I'm not going to ask you to do that. And it's very rare that when you open that door that a founder runs through it at that moment. But I often find is if you crack that door open sometime over the next couple of months, they might ask you, so what would it look like if I shut down the company? Or what would it look like? And I think we focus this conversation so much on shutting down the company. And I think that's because at the early stage, oftentimes bringing in management isn't an option. But I think as companies mature, sometimes the answer is just because you as the founder are tired or have hit your ceiling or capped out energy wise. The answer might not be to force the sale or to sell the business or shut it down. The answer might be find somebody, internal or external, who has the energy to keep going with the business. I always tell people all I expect from you is effort and focus. If you worked hard and you made the company a priority, you don't owe me anything beyond that. If you haven't done those things, then I'm probably going to have a different view on you as a founder and what you do next. But my biggest thing to me is I hate to see people waste their best working years on things that aren't going to work or aren't going to be meaningful unless they choose to do so.

What has been a more difficult conversation when you have to ask them, maybe it's time to stop entirely or maybe it's time to bring in someone new.

I think because I normally have these conversations with the original founder, not like a hired CEO. For a lot of people, we can argue whether this has gone to the extreme. I'd argue it has. For a lot of people, being the founder of their startup is a huge part of their identity and you're basically asking them to rip out a big part of their identity without always a very clear sense of what's on the other side. And I think that's psychologically scary for a lot of people. Who am I if I'm not the founder of this company and I'M not now the founder of a new company. I'm like, well, you're a human being with friends and family and interest. You are a person beyond your startup. But I think oftentimes at the moment I have this conversation. It's a time where someone's like working really hard to keep the thing alive. And I think sometimes people are just like, hey, like I need a job or hey, I left a good job to start this company. How am I going to explain to my friends and family that it failed? And so I think in many ways to me, like shutting down a company or leaving, it's a grieving process. That's why, that's why I'm so anti rebound startups and the notion that you just shut something down and you want to get back in the game and please don't do it, give yourself time and space.

That's a great segue into my next question because a part of the piece that stood out was stopping at the right time can sometimes set founders up for future success. So we've probably all seen cases where founders shut down a company and come back a few years with a better one. But, but how have you actually seen this play out?

I think 2022 and 2023 were very instructive years on this for me. Not all VCs or investors have the same perspective when a founder decides to shut a company down. We've had a couple of companies where I've been like, look, this founder doesn't believe this is working. I don't know how you make somebody work on something they don't believe in. They're going to shut it down. And I've had other investors say, I can't believe this person's quitting. I totally think they should keep going. They're like giving up too soon. And my reaction has always been like, that's what you would do if you were in their position. But you' of us are in their position. I'm a big fan of the old saying, never quit on a bad day. Sometimes I talk to people, I'm like, you're just having a really bad run. I'm not sure that quitting in this moment is the right decision. Not because you don't have the right to quit, but you might be quitting on a bad day. I've been surprised. We've had some investors who are like, I need this company to keep going because I don't want the write down on my books. We've had other people saying, I think this founder should be tougher and should keep going. And I'm like, at the end of the day, they run the company. We can judge the decisions that they make, but we can't make the decisions for them.

And same of what you said before, if you can't force the founder to quit, you probably also can't force them to continue working day in, day out on the company that they set out to build when they're like half in.

But I do think to the point of that piece, the way people exit really does stick with you as an investor, whether they wound the company down properly and we're able to get you all the documentation you need for audit. We've I've had situations where people just emailed me and were like, I'm quitting, I'm done, I'm walking away. And they just bounced. And you're like, wow. And I get it, you'd reached your limit and so, oh, there's a better way to do it than this.

Great post from Hunter. Always love reading all of the essays that come from him. Moving on to the second topic, it's an article by Forbes about Seraguo's latest fundraise. Seraguo, formerly of Greylock, just closed a $230 million second fund for her firm conviction. It's doubling the size of her first AI focused fund. Her ability to carve out a reputation as a top tier AI investor highlights a broader trend. More prominent VCs are leaving established firms to start their own. The article describ describes this as a VC reshuffling with top talent seeking to build their own platforms instead of staying locked into legacy firms with slower decision making processes and perhaps diluted economics, there's been a steady drumbeat of partners leaving top firms to start their own funds. So Charles, what do you feel like this means about the current state of venture today and where opportunity lies?

I think we've talked before about the concentration in VC and how the big firms are getting bigger. I'd be curious to see someone also cut the data and say of the 25% of capital that wasn't raised by big established funds, what chunk of that went to people who used to work at big established funds? My sense is that is a significant chunk of it. It's funny, when you leave to start your own fund, lots of people will call you and ask you about your experience. It is kind of interesting. And when I talk to people, a lot of it I think is people are leaving for good reasons. There's something that they want to see in the world that they feel like doesn't exist and they feel like they can't will that thing into existence at their current firm. And if you think about a lot of these big firms, a lot of them have very visible prime working age leadership in char of those firms. So if you're an up and comer and I don't know the specifics of everybody's carry, split and pay and manage, there's a lot of things that are unknowable. As an outsider, what I do know is that in most venture firms the people at the very top have a disproportionate amount of both economic control and simply operational control over how the firm operates. And if you're someone who believes in your own ability and thinks you are a good investor, the natural tendency is at some point to say am I better off staying here and trying to become the person who's leading this firm or am I better off striking out on my own? And I think some of this is economic. It is people saying look, I have a teeny amount of carry here and I don't have any management company participation and I don't have any control over how this firm is working. If I could raise enough money I could have much more say in control over how the firm is run. And I think a lot of the people I've talked to, that's their motivation. It's a desire to build something that better reflects who they are and their values and they want to really control essentially the UI of the firm mia more and it's, it's as much about the money as it is about control. And I think part of the reason we're going to continue to see an acceleration in this trend in my opinion, is we did sort of emerging manager 1.0 which was mostly people who were new to venture, people like me who were spinning out of like smaller firms. I think right now we're in a climate where when I talk to a lot of LPs backing a GP who's spinning out of a well known platform, maybe even a platform where you are already an investor, feels much safer than one of a hundred random from your point of view as an LP Emerging manager, people who were maybe a successful angel or an operator or spinning out of a family office, like the person who was at X name brand name firm, feels like a safe bet you could get through committee.

Sarah even acknowledged when she started she got a lot of questions around is success that you're going to have based on the platform that you had at your prior fund she said second fund. That question came up a lot less. I know you're involved in Screen Door and LP of multiple funds. Also, what are the things that LP should consider when they look at types of emerging managers and putting quotations around my fingers there who've left larger platforms and want to start their own.

We meet a lot of these folks through Screen Door and I always, I just ask them directly, how much of your success do you think was a function of the platform you were on? There is an answer. I won't say there's right answer. There's an answer that I think is intellectually honest and works for me, but I think it's actually unknowable for you as a, as a person. Look, I think it's a lot easier to get people to reply to you if your email address ends at a 16z or at, you know, pick your favorite brand name firm. I think founders pay attention, but I think also most people in this business realize that founders are choosing a firm and an individual. And I think as the individual, it's nice and satisfying to believe that who I am as an individual is more important than the name on the front of the jersey versus name on the back of the jersey, to use a sports analogy. But I think most of the people I found who've done the best can simultaneously hold two things to be true. One is that I absolutely got a tailwind in terms of access from the brand name firm. But who I am and how I relate to founders is also important. But also I found out people ask the founder, hey, would you have taken this money? If they're on their own, you don't actually, the founder can't really answer that question because it was a bundle. It was like Sarah plus Greylock. I think maybe a more relevant question is would you have taken Greylock's money without Sarah as opposed to would you have taken Sarah's money without Greylock? And so I think a lot of LPs try to assess this. And truthfully, I think the other reason this trend persists is if you look at the size of the debut funds that spin out managers raise, they're usually somewhere around $100 million per GP. If you wanted to use like a crude metric, most emerging managers who are not of that ilk are raising funds that are between 10% and 25% of that total. And knowing that you could raise a hundred million out of the gate I think changes the calculus of leaving both in terms of short term cash comp, but also in terms of the type of team and resources you can hire when you get started and it's just a different ball game.

And is that just based on LPs making the assumption that you don't need to have the $10 million pilot fund, like we're happy to give you the 100 to just skip all of that.

I also think when you've been operating at the scale of billions, operating at 100 million feels small. When I talk to my friends who are spinning out the idea of leaving and starting a $50 million fund, like you just wouldn't do it. You just stay. You'd stay and figure out how to be happy. So there's some like minimum threshold amount of money. But also when you're at these platforms, depending on your relationship to leadership, you might have access to LPs for whom writing a 10 million check into a hundred million fund for someone you've gotten to know on a platform, you've observed their work, the gps have given you some sense to their contribution can be an easier experience if you just think about as an lp, what we really want to do is I want to underwrite someone I've really gotten to know where I have some insight into their performance. Someone who's been a GP at a platform where you're an lp, you kind of have unfair access. On the diligence side, you can ask the leadership, hey, why is this person leading? Here's what they told me. Are you all investing? These are the deals they tell me they worked on. Is that true? And you might have met that person at agms for the last five or six years. You do sometimes have the ability to build a relationship and have more familiarity there.

Moving on to topic three, it's AngelList's latest State of Venture report, which provides a data driven look at early stage investing across 2024. After a more turbulent 2023, the market found some stability, but a handful of lingering challenges remain. There's a couple of key takeaways, most of which we've discussed at throughout the podcast. Seed valuations have remained surprisingly resilient. They're standing around a median seed round valuation at 20 million pre, which is actually back to nearly the 2022 highs. VC performance still continues to be stagnant, so funds from 2021 to 2023 vintages are relatively underperforming. Again, things we've talked about, but squeezed by higher entry valuations and a lower rate of markups over time. And then a new one, AI dominates deal flow. So through AngelList, specifically deals at the seed stage now fall into the AI category, far outpacing previous tech cycles like fintech and crypto. So the fact that seed valuations are still climbing despite weaker overall venture returns, I thought was pretty interesting. I assume a lot of this has to do with AI or stack safes, but how sustainable do you kind of think this model is?

I think we're in this very weird place in seed stage investing. You know, some things feel kind of like boil the frog and I feel like this elongated seed process is. We're, we're very close to actually boiling the frog. I think it was one thing when seed was a two year journey and then seed was a three year journey. And now I would say it's becoming more like a four to five year journey. @ least from what I've seen in our portfolio, it can be a four to five year journey where there are three financings, all of which you will hold on your books at cost for five years. You'll do the first one at cost and then you'll do two more safes at cost and you will end up with. And if it's a good company, you might end up concentrating dollars into a company and getting essentially no, credit it for whatever bump in valuation you're seeing from those safes, which means your reported performance as a seed fund will be muted. And I think this is becoming. One of the hardest things, particularly for emerging managers, is how do you talk about performance in a world with very few markups? Because in most cases a new safe, unless you have more liberal valuation policies, a safe at a higher cap isn't a markup. It isn't something that's going to show up in your performance until it converts. And also remember, the losses, though, will show up sooner. We've talked about this a ton internally. You end up in this dynamic where the old lemons ripen early. Bad news shows up early, the good news doesn't show up until much later. But in some cases the good news can be quite true. Like we've had 10x step ups on conversion and it's not because the new round was a 10X, it's because it's been five years. And if you go all the way back to the original safes, the new valuations are such that, like, it's a, it's a meaningful step up. We have one of those that's going to close in three weeks and we're going to get a 6x markup on a position, but it's only a 2x markup on the last safe. And so I think it's different also when you have later stake age companies that go long time in between valuation because usually those companies are mature. You can make, oh, they grew ARR from 10 million to 20 million. They doubled revenue. They're at $20 million in revenue. We think a company doing $20 million in revenue with these margins is worth X. When you're like, this is a company at 500k and ARR, I don't know what to tell you. And I think it puts a premium on two things. When I talk to RLP's, I think it's a lot easier to trust a GP when you've seen how they handle valuations and markups over a long period of time. Time and a handful of our LPs have been like, we give you a hard time about performance sometimes, but we understand how you mark the book and we know that you're conservative so we need the language from you. Not so that we are comfortable, so that we can explain to people internal to our organizations why they shouldn't be concerned. But I think if you're a 2021 brand new vintage manager who doesn't have the trust of long term LP relationships, I think it's hard to talk about performance, particularly if LPs might be like, well, have you been doing this job long enough to know which of those companies are doing well and which ones are actually in trouble? Are you trying to fool me or are you fooling yourself? These are hard conversations. It's funny, I thought by now we would have dealt with all of the 2021 overhang. I now think it's going to take until.

2027. Wow. What do you think in 2025 is in when you think about seed and venture and the dynamics there and what do you feel like is.

Out? If you cynically said, I just want to optimize for markups, then you should do buzzy AI stuff stuff because like that's where the energy and the action is. And if your goal is to like generate markups, I think that's a good strategy. I don't think chasing markups is what most people get in venture to do, but the practical reality is that like they help, they help with narrative, they help with fundraising, they help. The question I always ask myself is what's going to look like a good idea two years from now? Like, what are people going to look back and say, God, I wish I had had the foresight to do that two years ago. And those things always feel slightly scary and uncomfortable. And so I'm always like, all right, well, if this feels slightly scary and uncomfortable, we might be in the right.

Zone. Looking for things that are slightly scary, uncomfortable. And then I would add, maybe in comparison, feel a little bit more boring or less flashy is typically what I feel like the cycles you want to look.

For. To me, the risk of being all in an AI right now is we can't maintain this level of enthusiasm for a single investment theme for that much longer. Could it be another year? Sure. Could it be two years? Maybe. Is this going to be three years? I doubt it because at some point you, you get more feedback about what happens as things get closer, terminal or at scale. For example, we still don't know if spending hundreds of billions of dollars a year on data centers and expensive models is really the right approach, but we are going to run that experiment. But at 2027, people might say, you know, we spent $200 billion on this stuff. Was that a good.

Idea? We are all out of time for today. Thank you, Charles, for stopping by and thank you to all our listeners for listening. Please like and subscribe and we will all talk with you next week. Thank.

You. Bye.