Episode #3: Nnamdi Iregbulem, Jordan Nel, The New York Times

If you're at a fun, that puts a heavy weight on making sure that the whole team is on board. Maybe unintentionally you are treating yourself to look for consensus deals. Again, fun like ours where there isn't that intense emphasis, it has become very empowering.

It's the week of October 7th. Welcome to the Learning Corner, a Precursor Ventures podcast.

Welcome to the Learning Corner by Precursor, where we talk about the articles and goodreads that caught our team's attention over the past week. I'm Mia and I'm joined by Charles and also another member of our investment team, Marina. Marina, welcome to the Learning Corner.

Thanks for having me.

You mind sharing just a little more about yourself and what you're excited about lately?

Yeah, I had been on Precursor investment team for the last three years. Before that I spent time on the stock market space about five years covering semiconductor stocks. So big pivot from stocks to pre seed. Things I'm excited about. Now it's honestly just founders people that I would love to work for. It's across cybersecurity, retail, tech, insurance tech. I'm trying to put more emphasis on who the founder is and why they're so excited about this space and less so about what the space is. Specifically.

Love it. Without further ado, let's get it started and we can get into the topics for this week that caught our team's attention. So kicking it off with topic number one, Seed Valuations Aren't Valuation. This was a piece by Namdi Irregulum Substack from Lightspeed. He did a really impressive analysis on seed valuations over the years, conducting all sorts of comparisons between trends in later stage valuations, public tech valuations, and the effects of shifting interest rates. And what he concluded was that seed valuations are really unlike any other type of valuation in the market in that they are completely unaffected by really any of the affirmation comps. And the closest thing he was actually able to find similar trends with was actually following tech worker wages over time. Regarding seed valuations, Namdi said. Rather than venture capital, they seem to be a proxy for the human capital of the founders and early team. So Marina, question for you. Your entire venture career has been within these pre seed stages, so I'm curious to know what you thought about the article and what insight stood out the most to you.

The first thing I thought was I am so glad someone finally said it. A lot of what I had to do since my previous career in the stock market to now is retrain my brain on how to look at companies and these prices so differently in stocks, every price has a reason behind it. And you can see the math and the model that led to that conclusion and that number and having to shift so differently to pre seed where that's just not the case. So when I started seed investing, it was honestly a very large learning curve to go from that to understanding that truly everything is subjective. And these valuations we put on pre seed or seed companies, there's no model or math that we can show that led to that valuation. It's different factors. And if you're a founder, you can of course ask your investors how they got to that valuation for you, but you might get different valuations from different investors depending on what sort of factors they value. More of those factors can be anything from the current general market, their company progress, or the founder's background. It's more of an art than a science. And maybe if you talk to a bunch of different investors and you get so many different thoughts on valuation, you'll end up in a similar range. I imagine that the number itself will be very different. And I just really appreciated Nandi saying that very bluntly. The fact that there's even data to support it was really great to see.

It's great to hear the comparison between your previous work and then now, and how much that affects and changes the way you think about valuations. If I'm to think from the shoes of a founder after reading this article, the thing that I might hear is that most seed investors are quasi arbitrarily pricing my own head as opposed to the company itself. So anything specific that you found in founders that warrant higher valuations?

Like I said, it's multiple different things, but Charles and I actually a few years ago took the time to create this sort of precede valuation decision tree, if that's what you want to call it, just to make sense of it all. And we had these three main buckets which included first how competitive is the round, and then from there how experienced is the founder, and then from that, how large is the round size and those three main buckets, depending on how you answered each one of those three factors, it put you in a different range of valuations and it can be anything from looking at a sub 8 million dollar valuation to over 20 plus million dollar valuation. It's not an exact science. It, it was an art and it's something that was there just to ground our thinking.

I think at the end of the day, the things I find that matter are the founder's background and the founder's background is oftentimes a proxy for access. So I think in general, the more access you have to venture capitalists. Repeat founder, you went to Y Combinator, you're leaving a highly regarded company, the greater the probability that you're going to have leverage to push prices up. And at the end of the day, I think most of these seed rounds are really about supply and demand. And if you are a founder with a highly sought after background and resume building in a category where people think you have an advantage, you as the seller of equity, as the founder, have most of the leverage over the buyers of the equity. Also, I think it matters who's bidding. There are some firms where seed is not the main event at that firm. They care less about the price they pay at seed because their strategy is to make sure that they're in great companies at seed and that they can lead the Series A round. There's a bunch of new branches that I would probably add to that decision tree. But in the end, I think most seed prices are about the relative power dynamic between the founders and the buyers. And anyone who's been to YC Demo Day has seen that dynamic play out in real time where founders who have limited equity, they're willing to sell and a ton of potential buyers in the room are oftentimes able to get better valuations and prices than they'd get in a world where they didn't have that dynamic. So I always ask myself what Marina said, which is like, how competitive is this round? Because that gives me some lens on the room. We have to move on valuation and whether we're likely to land closer to something I like or something that the founder likes.

Shifting it from a different perspective. Charles curious, actually, how LPs should absorb and digest this information. Seed valuations are an enigma and there really isn't any specific math or it's more of an art. How do you think that they should react?

Boy, I. I think it's interesting. Sometimes when I talk to limited partners about what we do, they go, wow, the valuations you get are very good for pre seed. Those are low valuations and I say they are, but they're not the lowest because some things are cheap for a reason. Sometimes I meet companies where the valuation is. So my conclusion is either there's something wrong with this company that I haven't found yet, or these founders have been pitching people who've taken advantage of them and there's sometimes we've paid high valuations that are outside of the model because I believe relative to the future potential of that company. It's fair, a precursor. We have what we call these celebrity seed deals, which are seed deals started by repeat founders or people who have a lot of access to capital. Those can be five to 10 times as expensive as our average pre seed deal. And in many cases I'm like, it's worth it. This person's access to capital, their expertise, makes the probability that company will become valuable in the future feel much higher. So whenever I talk to LPs I'm like, there's a range of valuations on average that work for our fund. Sometimes we will go above those valuations for special opportunities and in many cases going below them is maybe more risk than makes sense to take. Or maybe you're dealing with companies that have like more fundamental issues.

Love the insights from both of you guys. Moving on to the next topic, two Big Funds, Small Funds and the Changing Tide this is an essay by Jordan from Hummingbird and Nomad found on their substack called Jordan's writings. It really summarizes the trend of LP slowing funding for emerging managers amidst this venture slowdown and opting for allocations in bigger funds. He challenges this shift, arguing that it's actually the time to invest in smaller funds who are less susceptible to consensus and investment narratives when elaborating on who has the opportunity to actually generate real returns in a market like today's, Jordan said quote with the big funds now facing deployment pressure, doing more expensive deals, and having trained a generation of investors to source and sell rather than pick, the feel is more open than most think. Another memorable quote from this piece is regarding that two decade long trend of consensus driven deals being susceptible to the steep bid ups from C to Series A. And Jordan says quote this dynamic has created a generation of investors who are excellent networkers and salespeople, but fairly limited pickers. Charles, I'm curious to know what your thoughts are here.

I enjoyed reading this article. I felt like it spoke to a lot of the things I've observed. One thing I will say is I am sympathetic to the plight of LPs. If you're investing in a multi stage fund, there's a good chance that some of the companies in that portfolio that are Series B or C are names that you've heard of before a stripe or a databricks. When you're investing in a pre seed or seed stage fund, there's a high probability you've heard of none of the companies that managers invested in and that's the way it's supposed to be. Because those folks are supposed to be finding companies that other people haven't discovered yet. So then you're left with a question where if I don't understand the assets that are in the box, how do I get some sense for whether or not this person's any good at picking? And one, one thing that became, I think very fashionable in the LP community was I know one way to do this. Let's look at graduation rates from seed to Series A for these early stage funds. And let's not just look at graduation rates, let's look at who's doing the A's. Are there A's getting done by the tier one VC firms or are they getting done by other folks? Because if you're good at picking companies that the Tier 1 VCs like, you're part of this sort of a link in the chain of like pre seed to IPO. And I think for a lot of LPs, somebody who's good at finding companies that Sequoia also thinks are interesting at the A, that's a signal of quality by proxy. And so taken to the extreme, one could imagine attempting to construct a venture fund where your sole goal was to try to pick the kind of companies that you think would appeal to a Tier 1 VC fund 12 to 18 months later when it's time to get those companies financed. And if you had insight into what those firms want, you could build a very interesting portfolio of companies that those folks would be interested in and you would essentially look for the thing they're looking for, but sooner. And I think there's a set of LPs who said I want that. I want the people who are the sources and fodder for a 16z sequoia index founders fund. I think the challenge is that just because those firms do the A doesn't mean the company's going to be successful. And just because those firms don't do the A doesn't mean the company is going to be a failure. And two, I think it's really hard as a seed stage investor to know what the people who are next in the line from you are going to want 12 to 24 months from now because the world is very dynamic. The thing that I think is true though, having talked to some of my friends who were younger partners or principals at other firms, getting a deal done by one of those big firms as a follow on helps you internally in your path to promotion or your basic relative ranking in the firm. So it did, I think, to his point, create this incentive for people who were trying to progress in their careers to find companies that they thought had a high probability of getting a follow on round done by a tier one firm, which you can do by a couple of ways. One is spending time with those people, getting to know them, greasing the skids so that when you send them a referral it's warm, but also trying to figure out what they want to see and going and looking for that thing which is really different from doing your own independent work. I'm not saying one is better than the other, I'm just saying they're different. I also just think there's a, in my mind in talking to LPs there's a fundamental split in a lot of the people I talk to. Some of them have essentially told me we think all of the alpha and venture is going to come from these repeat founders and that the multi stage funds are going to bid these deals up and that and most of the future success is going to be very high priced seeds started by repeat people. And that's the game and that's where the money is going to be made. And the high prices on entry will be offset by the high prices on exit. And there's another camp of LPs I've met who was like that's absolutely not going to work. The high prices on entry are going to eat away the profits and the opportunity is really in smaller funds who are doing things differently and that the big funds are going to have a challenge generating meaningful returns because the power law scale outcomes that they're going to achieve achieve will not be big enough to move the needle given the size of their funds. And so obviously depending which camp you sit in, you have an incentive to believe one or two of those versions of the world is true. I tend to believe that both are true. There will be companies like OpenAI that will never do a $1 million pre seed round because the context of what they want to do and their ambition means that you just need more money out of the gate. And there'll be other companies that start and follow a really different path and are very successful. And I don't think these two things are in conflict. But I do think we're coming off of a world where a lot of the analysis or a lot of the questions we got from LPs from 2018 through 2021 was what's your graduation rate? And who's doing the as? And if the answer was tier one venture firms, you got a gold star. And if it wasn't, you had some explaining to do.

It's so interesting. I feel like everything in venture is they're all like little microcosm ecosystems of itself. I have friends who work at multi stage firms and they lament on how the job is not actually finding the best deal, it's finding the deal that your partner will do. And so similar when do you stop trying to cater to the next fund and trying to feed them that so that LPs will provide you more capital? One of the takeaways from this piece was that it is a great time to invest in non consensus alpha type funds in hopes that they invest in companies earlier than the big funds through their punchier bets and insights. So Marina, as someone down on the ground would actually love to get your perspective on consensus versus non consensus deal sourcing and diligence.

It's so easy to get carried away in thinking about what other investors are looking at. At precursor we operate with a somewhat different and unique model than others and we never go through a typical IC process where everyone say yes or majority say yes. Voting just doesn't make sense at this really early stage because again, everything is source, subjective and mia. To your point, if I'm only thinking about what will the entire team like, I'm not thinking about what do I love. I think if you are part of that generation of investors and you're at a fund that puts a heavy weight on making sure that the whole team is on board, you end up looking for companies to bring at the table that everyone's going to like. And maybe unintentionally you are training yourself to look for consensus deals. Again, fun like ours, where there isn't that intense emphasis. It has become very empowering. I've learned to really trust that gut instinct in me, telling me that this founder I'm talking to is really something special. And over time that has really influenced where I look for founders. And today I've spent a lot of time building my own outbound channels so that I don't have any sort of external signals from other investors on who they're looking at and what their team liked or didn't like. And I think that's helped me see a lot of companies that others haven't seen yet and form opinions on things before anyone can tell me something different. In terms of diligence, it's a delicate balance. I often ask the opinions of experts in the space just to make sure I'm asking the right questions, but I've always been proud of my ability to still trust myself again. It's just a delicate balance between listening to valuable input from others, but also having the confidence to trust my own judgment and being very okay with disagreeing with others when it's appropriate. I think if you're at Edwara Fun, that does put that intense emphasis on making sure the whole team was on board and signaling for the future. It's a different sort of mindset and it can be harder to become comfortable with that unknown and bearing opinions like.

I've made a bunch of investments that people made fun of us about at the time. It just doesn't bother me. I think it's like for me, like a necessary attribute. If you're going to be successful at Pre Seed, you have to be comfortable doing things that other people will look at and they will say, I really don't understand why anybody would invest in that company. I'm like, that's great. Then either I'm really wrong or I'm doing my job. One of those two things, and maybe both of them are true. But I do think this sort of precede being comfortable saying we're going to invest in this company that no one else understands because we think it will eventually be well understood and appreciated. And the path to getting there requires sitting out on your own for a while. And that's not for everybody.

Yes, definitely not for everyone. I'm glad we were able to talk through the realities of consensus driven investments. Got to kick it off to the last topic. Topic number three A venture capital firm does something rare. Give money back. It's our final topic and it's an article from the New York Times and it's about CR V planning to return $275 million from its 500 million later stage focused select fund to investors. Four of the firm's partners said the move was due to changing market conditions, particularly for mature startups where valuations have become too high relative to potential returns. The firm argued they are seeing fewer opportunities for high growth late stage companies and is focusing instead on younger, earlier stage ventures. So while the Select Fund was focused at more mature startups, this decision I'm sure affects every type of fund. Gerald, what did you think when you came across the article and how does it affect the way that we think about the pre seed fund land, if at all?

I think when I read this I was like, this makes sense to me. If you dial back to 2016, 2018, that's really when a lot of people started looking at Opportunity funds or Select Fund, Growth Fund, whatever you want to call it, some dedicated vehicle that allows you to either stay in your best companies longer with a dedicated pool or buy access into growth companies that maybe you missed earlier. And I think that strategy felt great because everybody was getting these markups and they were significant. And the pro rata price to pay to stay in these companies was high. And in many cases people said, wow, you do the math. You're like, boy, we didn't do our pro rata in the series B and C of a bunch of our best companies. And if you do the look back and had we had the capital to do the B and C round now that the company's going public in the spac, boy we would have made a lot of money. And I think what ended up happening was a lot of people did that math and said the answer here is we need a dedicated pool of capital to invest in either follow ons for ourselves because we're leaving all this money on the table and we have access to these great companies. And then I think the entire valuation environment changed. I think that made sense in a world where people were getting 20x multiples and companies were highly valued. Then the world changed. And I think as the folks from CRV mentioned, the opportunity set looks really different today. I think most people don't feel the need to concentrate and put more money into their series B and C companies. There's not so much activity in that market either that you need piles of cash to do it. And I think it's an intellectually honest admission that like the world today is different and I think it's very hard to give money back in venture. They could have just held onto it and said we're just going to look harder or we're just going to wait longer or we're going to find things. I think at some point you look at the world and just say the amount of capital we have is too much for the opportunity set in front of us and we're going to give some back. But it's really hard to give capital back even if it's a select pool which maybe has a different fee structure than your core fund. There was some interesting commentary on X around this article with some people saying maybe you just can't find or access the companies that are big enough. And I think we're in this interesting bifurcated world where you have a handful of highly valued private companies that are worth north of $10 billion growing, or some cases north of $100 billion now in the case of SpaceX and OpenAI and then you have a bunch of companies that are simply valuable that are like worth 1 or 2 billion and there's this huge gulf in between. And I just don't think people feel like they need as much money. For the companies that are in between, the ones that are expensive but not crazy, you can probably do your pro rata for those out of your main fund and the ones that really do take off, if you're systematically in those companies like a founder's fund, you already have a big enough vehicle to do what you need to do. So I think the era it felt to make the era of the opportunity fund ended three or four years ago. A lot of LPs were like, look, we don't want to do these anymore. We'd rather fund managers to do whatever their core strategy is. And unless you're going to force us to do this Opportunity Fund, we prefer you to just focus on the main thing you do. And I think this is the beginning of the unwinding of the end of the Opportunity Fund era. There'll be some people who have portfolios where this makes sense, but I think a lot of other people will conclude we don't need that multi hundred million dollar vehicle we raised because the opportunity set just doesn't support it anymore.

Well, son, we are actually all out of time for today, but Marina and Charles, thank you so much for making the time today. Thank you to our listeners for popping by. Please like subscribe and share with a friend and we hope to see you next week.

Bye bye everybody.

Bye.