Episode #9: Jamin Ball, Hunter Walk, Menlo Ventures

One fact that I remind every portfolio company of ours, whoever's money you take, you are buying into their business model. I think there is a bunch of founders I've met who've taken money from funds where they didn't fully comprehend that winning for that fund meant not 500 million, not a billion, but $5 billion.

Outcome it's the week of November 18th. 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 caught our team's attention over the past week. Topic number one our first article comes from Jam & Ball's newsletter Clouded Judgment titled Misaligned Incentives. Jammin also joined the podcast this week in Startups to elaborate on what he wrote. He dove into the structural misalignment between venture capitalists and founders around fundraising and growth expectations. Jamin calls out the differences in how founders and funds can be successful. For founders, it will always be growing and exiting a larger company while maintaining a decent ownership percentage. For funds, we share the interest of a successful exit, but also can see financial success in management Fees, the classic 2 in 20 makeup check. Jammin argues that misaligned incentives often lead to decisions that aren't in the best interest of the company's long term success. The Jammin, similar to other investors, also warns founders about raising too much money too soon for all of the same reasons that if you were in the venture space between 2020 and 2022 you probably also share that POV. But he wants founders to question is the highest valuation offer from an investor taking place because they are the most convicted or because of the inherent misalignment in quote unquote success and they are playing a deployment game? I doubt that there are ICs taking place where partners are full blown agreeing to write 50 to 100 million checks because they simply need to move money. But I do think some funds just have more flexibility into loose underwriting processes, but wanted to get your perspective Charles on that entire dynamic and also maybe what conversations with founders might have looked like in our own portfolio who maybe have encountered this fork in their own like what questions go on in their.

Brain. I have so much to say about this Mia. I think first and foremost I think it's really hard to convince founders to take a lower valuation unless there's a real mitigating circumstance. So in most cases I wouldn't always say that the highest offer or bid is the bid that wins in our competitive rounds. I would say most of the bids tend to be clustered in a pretty tight range. And I think the only time I've been able to convince founders successfully to raise money on a lower valuation is when the person making the offer has essentially a sterling reputation or brand. So, you know, if it's a Sequoia coming at a price that's below other folks, given their track record of success, given what I've seen them do to support companies, there are some founders who will decide to take that can believe. There are other founders who are just like all of you. VCs make promises ex ante. There's no take backs. I have no way to know whether any of you will do any of the things you've promised to do in terms of value add after I take the money. So why not just take the highest offer and deal with the consequences later? I think most founders on the one hand can intellectually say raising too much money at too high of a valuation is a bad thing in the abstract. And most confident founders I know say, but that will never happen to me or my company. That will happen to somebody else whose company is not as good and where the investors overpaid. Second, I think VCs, we compete with each other on a lot of dimensions. One of those dimensions is price and valuation. And I think there's a lot of firms who say, I am willing to pay up to win that deal. I remember when Greylock did Facebook at a $50 million post and everyone's like, how do you underwrite that? Turns out that was a pretty great investment. I think about when I think it was Keith who did stripe at a billion. It was relatively early and a lot of people said, gosh, a billion dollars for stripe? Like, how have we gotten ahead of ourselves? Turns out that'll probably be a pretty good investment. Early investors in OpenAI probably feel pretty good about where they sit right now. I would separate the question of like, talking founders into lower valuations is very difficult because also founders exist in a community where sometimes valuation is vanity. I know people who do want to be able to go to the cocktail party and tell their friends, oh, you raised at 200. I had similar metrics and I raised at 450. And that absolutely happens. So I think it takes a very evolved founder to say, I'm going to forecast the future state in which I'm going to regret this decision. And rather than deal with it then, I'm going to deal with it now. Because by taking a lower valuation. So that I think it's just a hard conversation to have. The other thing I'll say is it's important to think about one fact that I remind every portfolio company of ours when they go to take money, whoever's money you take, you are buying into their business model. So whatever the dollar they give, you need to do under their model, you need to live up to that. I think there is a bunch of founders I've met who've taken money from funds where they didn't fully comprehend that winning for that fund meant $5 billion outcome. Not 500 million, not billion, but $5 billion outcome. And for those funds, they're moving money in large blocks and their view is, hey, we need to find companies that we think have a good probability of getting to $5 billion because nothing else matters. The other thing I took away from both the article and the podcast is it's important to remember as a venture capitalist, you have a portfolio, you're making n number of investments per fund and you need a very small fraction of them to work out. If you're a founder, you have one bet. And so if you've got a big venture fund, you're going to make a lot of money on fees. And if you find a few home run companies, you'll also make a lot of money on carry. If you're a founder, you only have one shot. You have your ownership as a common shareholder sitting behind preferred in order to make money. And it's just a different calculus. There might be outcomes for a founder who raised at a high valuation that are interesting to you personally but do not achieve the objectives of the fund that you raised money from. And that always creates friction. And I think the VC business is a business of outliers. It's trying to find these rare companies and if you're not one, life is hard. The last thing I'll say is as funds have gotten bigger, it's not that I think people have pressure to deploy. They certainly have more people writing checks. And the ability, as you mentioned, to be flexible on valuation has gone way up. And I see this a lot in seed where for a multibillion dollar venture fund doing a $5 million seed round on 50 million posts doesn't really matter because if that company does well, you're going to buy up in the A. And if it doesn't, losing 4 million out of that $5 million round in a multibillion dollar fund, it's a rounding error. But if you're a price sensitive seed fund, you can't do that. What I've seen is like as funds have gotten bigger, the need to deploy capital has gone up. So you know, if you're going to write a $50 million check into a company, that puts kind of a floor on what the valuation's going to be in order for it to make sense for both the founder and the check writer. And to me that naturally pushes valuations up. So some of this I think is also just driven by the supply and demand dynamic. With capital, there's a lot more money chasing good companies. So the good companies I think get bit up. I think it's good to highlight the differences in the way that VCs and founders make money. But I found it very difficult to convince confident founders that they're going to up regretting taking a high valuation, particularly from a great firm. I think the last thing I'll say is we still don't know what's going to happen with all of the hedge fund growth equity money that came in 2019 through 2021, whether that's SoftBank, CO2 Tiger. We still don't really know what's going to happen with all the companies that took that money in terms of outcome. So I'll be curious to see whether there are founders that really regret.

That so much of it is More Theory versus Reality Jamin was talking about when you're a rocket ship type of company, you shift from this transition of orig hiring a bunch of missionaries. So the people were so passionate and so tied to what the company is trying to build that they couldn't imagine themselves doing anything different to becoming something so well known and perhaps overvalued that maybe you start attracting mercenaries. People see the value and the upside in joining the company. He talked a little bit about the perils there. Again, more in theory versus what happens in reality. I know a bunch of startups who would love to have great mercenary employees. So think your top engineers at a massive tech company come and sit with them for a month and then leave. I agree with a lot of what Jamin said, but then I also try to apply it back from what actually happens in the real day to day world of a.

Company. I tell so many companies there's only two startup hiring problems. One problem is when your company is unknown, you literally cannot get the attention of the people you want to hire. And then when your company is believed to be a sure thing, you have to work really hard to keep the wrong kind of people out of your company and you're in one state or the Other I've seen people flip and they're like, wow, we're getting all of these great resumes. All of a sudden people who wouldn't reply to our LinkedIn messages are suddenly like cold emailing me as the CEO and I'm like, just be careful. Those people now think your company is a safe bet and they're going to bring a different kind of energy than the people you were hiring before. It's always a hiring problem in a startup and you have to figure out like, which one of those two states of the world you're.

In. One last point. Jamin suggests that the one way to kind of realign incentives is to focus really more on sustainable growth rather than growth at all costs in this really competitive funding. Do you think that that's a feasible way to approach, especially in the earlier stages? I just feel like the benchmark for success continues to raise and maybe arbitrarily for founders every.

Quarter. So, I mean, we talked earlier to your point. I don't think there's any ICs or people are figuring out how do we take this wheelbarrow full of cash and get it out the door. But I do think there is a business model element when you're a larger fund, which is you need to get the money to work in your best companies. Going back to the realm of theory, it is possible that a highly capital efficient company that, let's say only raised $25 million in venture capital, became profitable and compounded for a really long time, might not meet the capital deployment needs for a really large venture fund. Because they might say, Yeah, I made 50x my money, but I only had $10 million in the company Series A. So 50x my money, it's half a billion dollars. But I'm trying to return 10, $15 billion to my LPs. This sounds crazy to say half a billion dollars does not help. It doesn't help. And so I think it is very possible we're going to end up in a world where there are capital efficient companies that end up raising the majority of their capital from smaller funds who don't have a capital deployment pressure. And there'll be ideas like LLMs and rockets and defense that are very capital intensive. That will be the domain of funds who can put hundreds of millions of dollars to work in a private company. And we're 10xing that hundreds of millions of dollars that's been put to work would move the needle for them. And you might end up in a world where like the source of your capital is going to be a function of the nature of the business you're trying to build. And there'll be some ideas that just don't make sense for small funds, and there'll also be some company structures and types that don't make sense for big funds. I kind of feel like we're awfully close to that world right.

Now. The next article is Hunter Walk's thought provoking blog post Winning at Seed isn't just about when to buy, but increasingly also when to sell. So Hunter discusses the EVOL strategies in seed investing, suggesting that the traditional buy and hold approach may not always be the most effective. Instead, he highlights the importance of strategic exits to maximize returns. We talked about this last week with the essay from Sapphire Ventures, so we know that this concept of selling positions to return liquidity is important to LPs. One thing I've been thinking about though, is that very few investors are spot on when it comes to making perfect investments at the right time. I feel like you can spend an entire career trying to do that, but even fewer will know the right moment to jump out of an investment. I actually wish that we had Hunter on this call right now, because what I would want to ask him is, okay, we need to start prioritizing secondaries or thinking about selling off positions. How do you even begin creating a thoughtful strategy around that as a seed.

Investor? So it's funny, I had a conversation, I want to say five years ago with Jenny Lefcourt at Freestyle and two years ago with Rebecca Caden and last year with Will Quist, all on this topic. And the interesting thing is a lot of people I've talked to, they just have some framework for selling. And those frameworks can be anytime a company hits XYZ valuation, we try to sell 20% every round beyond round of a certain letter number. We're trying to be a net seller along the way. Any company that hits some other benchmark, we have a selling discipline. The goal is to get our cost basis. So I found the firms that are good at selling all have some kind of programmatic process in place that helps tell them when to sell. Because if you rely on emotion or feeling, I think that's why most VCs don't sell. Because the things you should sell are the things that are doing well and appreciating. And you know, you talk to limited partners, sometimes they go, why don't you sell them? Or you go, well, the stuff I'd like to sell there's no buyer for. And the stuff that I get calls for I don't want to sell. So here we are. And I will say this, almost every managing partner I know, regardless of Fun sides, is thinking more about how to become more disciplined about secondary selling. And there's two things I think that are getting in the way of this. A few years ago I wrote this blog post called like there's only 100 points of equity to go around. Which is if everybody wants to buy more equity in a startup, eventually you hit the absolute limit at 100%. And the only way for this to work is early people have to sell to later people. And that is not something that's been institutionalized in venture the way it has been in private equity. And second, the stigma around selling needs to change. I think the latter has already happened. I would say many founders I know are secondary sellers in their own companies. In the Series B. I still think there's a stigma question around if you're a major investor, who's on the board, who owns a big chunk of the company. I do think engaging in secondary transactions in the early stage of a company's life probably sends a signal you don't want to send. If you're a small seed fund and you're selling alongside a founder in an organized transaction, I don't think that creates the stigma that it used to. The challenge is like figuring out how to have that conversation with the founder in a constructive way. But I think this liquidity pressure that LPs are feeling is real. I don't think hold periods for private companies are going to come down because there's so much money in venture capital and private in private markets. Now if you're a hot company like a DataBricks or an OpenAI or you name your favorite top 10, if you want to remain private, you can take down billions of dollars at a time, in some cases several times a year to remain private. And you can do tender offers. You can give employees and shareholders all of the features and benefits of being public, like the ability to transact in the stock, the ability to sell relatively frequent updates to price without actually having to go public. And I think for a lot of private companies that's an attractive thing. And I'm very curious to see what the norms become because right now we don't have norms. We have sort of one off opportunistic, hey, we should probably sell. I'll be curious if we get to a place where it's normal at the Series C that all of the early people are selling to the Series C lead to enable that person to get the ownership they want and balance founder dilution. And it just becomes customary that that's what early funds do. And I think the norms are the big thing. But a lot of fund managers I think for the first time are thinking about, well, what should our policy when we have our own policy at Precursor about how we think about secondaries and when to do it. And the biggest change I made after 21 was our policy used to be, oh, we're a default holder even in these later rounds, but we should have a conversation about selling. And now it's like, no, we're a default seller who can be talked into holding if selling is disruptive in some way, shape or.

Form. The final topic is the Menlo Ventures article titled the State of Generative AI in the Enterprise. It provides a detailed look at how generative AI is being adopted by enterprises, highlighting both opportunities and challenges. The piece emphasizes that while AI adoption is accelerating, enterprises are increasingly cautious about ROI and alignment with core business goals. This aligns with a recent TechCrunch piece noting that AI scaling laws are hitting diminishing returns. This may explain why enterprises are now focusing more on practical applications of generative AI rather than pushing boundaries of compute power. So in the article it was revealed that companies are split in terms of buy versus build when it comes to AI solutions. So 47% of solutions are developed in house while 53% are sourced from vendors. This was a huge shift from 2023 when Menlo Ventures reported that 80% of enterprises relied on third party generative AI software. So in short, enterprises are feeling more competent in standing up their own AI tools. So if you're a third party generative AI software company, what should be your focus in the next year, do you.

Think? I think there's always this pendulum with new technology where a lot of times companies go, we don't understand that thing. Let's bring in Deloitte or at Kearney or let's bring in a consultant to do a study for us. Then let's go buy a commercial off the shelf product and use it. And I think what's probably happening with AI is the engineers and teams at these companies are also tinkering and hacking on the side. And I'm sure now that they've been doing that for a year, they're like, oh, some of the things that these companies are selling us, like we could do this ourselves. Like we know how to use the OpenAI API, we know how to talk to anthropic withdrawal, llama, whatever it might be. Maybe we don't need to pay for this. Maybe we can do it ourselves. And if this follows the historical cycle, people buy stuff, then they go, we can do this in house. Then they build version one and then the work required to keep up with the rate of change and feature requests makes people realize while we could build this in house, it would be much better to buy a solution from somebody else who's going to continue to stay on the cutting edge and is going to build something that really works for us. I don't know how long it's going to take to get back to that third phase. The third phase is usually as a software company where you make money because your customer has already gone on the journey of trying to do it themselves and has concluded, either we can't or we don't want to do that and we're not going to. And I think that's the interesting thing. When I read it though, there are so many interesting nuggets in this article. Like a lot of this stuff, you know, I've been beating this drum internally that a lot of this stuff is experimental, it's not really production ready. And the article talks about how people are bumping into real issues and challenges. Whether it's hallucination, cost, workflow, rolling this stuff out at scale is not easy. So if I were a generative AI company, I would be trying to figure out what are the things that I can do as a specialist that my customer won't be able to do six to 12 months from now. And in some cases that's just like deeper integrations, it's more workflow, it's more industry or problem domain specific technologies. It's a lot to do. But if I were a generative AI company, I would actually be excited that customers were trying to do this stuff on their own because the likely outcome is they won't be able to support the things they're building. And conversely, if your customers were able to build and support the thing that you were selling them on their own without much friction, I'd question the value in the problem you were solving. Like, I know a lot of companies that once upon a time built their own CRMs from scratch. They did. They're like, I can do this on my own. And then you're just like, oh, this is hard. Maybe we should just go buy HubSpot. Maybe we should just go buy Salesforce. Maybe we should just go buy a CRM product that, you know, has developers working on it every day trying to make it better, rather than trying to support our own thing. The least surprising thing, though, is I can't imagine being a company who would go to their board of records and say, we are spending no time whatsoever with AI we don't care. It's not important. We're turning a blind. I don't think that's possible. So I think, to me, it feels like we're still very much in the company's experimenting with where can we get real value? And maybe the era of let's play with AI because it's cool is turning into, like, let's figure out how AI can actually help us solve business problems and improve.

Roi. Well, we are all out of time for today, so thank you to our listeners for tuning in to this week's episode. Please like and subscribe and share, and we will talk with you all next week. Thank you. Bye.