How Valuable Is Relevancy In Venture Capital?

Investors are actually rewarded on the shots that they take, not the shots that they actually make.

The average venture firm. It's not a good investment. The real question is, show me that you have a history of being able to find outlier companies. Whether I've heard of those companies or not, it doesn't matter what I think about secondaries, their gravity, they are just a part of the ecosystem now in the absence of being able to underwrite portfolios at the company level. If I told you you have two choices. This fund has 10% of its companies that get the Series A. This fund has 50% that gets the Series A. Knowing nothing about the underlying companies, you might say o give me the person 50.

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 teens attention over the past we Our first piece is episode eight from the relatively new podcast Uncapped, hosted by Jack Altman, where he interviews First Round Capital's Josh Hoebelman and reflects on how venture has evolved from a boutique high craft discipline into a fragmented ecosystem. There's a lot to dive into here. Josh's Blacks on the vacation of venture, harvesting your winners in bubble times and continuously creating value as a fund manager by operating like a company and constantly seeking learning opportunities. Josh and Jax spoke a lot about the social capital that is relevancy as an investor and how it can earn you access to hotter deals and meetings with larger LPs or investors. This relevancy is often fueled by firm wide marketing efforts and broader branding and medium relevancy is one of those really squishy terms in venture because the beauty and the curse of the private markets is that you as a venture fund can selectively choose what to share with the world and shape your brand. So how do you think about striking the balance when it comes to chasing relevancy? And from an investor's perspective, how much weight should we actually place on it?

I thought the podcast was super good. I went back and listened to it a second time. I think this relevance thing is really interesting and sometimes I'll be in meetings with people like oh well, they're just buying logos. They invested in this hot company really late just to have the logo. But what if logo buying works? What if being able to say I'm an investor in OpenAI? What if a naive person says well who cares if you bought in at some crazy high valuation or a seed fund? You can Say I'm an investor in OpenAI and I think a lot of founders, I think logically, oh, I want to take money from the people, people who are already invested in the very best companies because a those people have good picking ability, they have a good brand halo, maybe they introduce me to that company. So I think there is some logic in buying logos. And I think it's also important to remember, you know, when I started in Venture 25 years ago, there was not as much supply of capital. I don't think venture firms had to work as hard to differentiate themselves and be chosen. Now as the podcast mentioned, there's I think Josh mentioned 10,000 venture firms, 20,000 check writers, anything you could do to stand out and be chosen and be top of mind. I think one of the fun things for us is we have well over 250 active companies, 50 of whom are fundraising at any point in time. I get to see who they want to meet. And who they want to meet is usually not a function of what firms have the highest IRR or tvpi. It's usually like, oh, this person produced a piece of content that I read about my market and I like them. Or this firm shows up in all of these searches that I do for being an investor in a bunch of categories that I care about. And I think with private market the founder has to choose you. So anything you can do to increase the odds that you'll be chosen. And as Josh mentions in the podcast, volume is another way to be adjusted. If you are everywhere, if you're in all of the right rooms, if you're seeing all the most interesting companies, you'll bubble up. And it's not surprising to me that oftentimes the firms that founders are most interested in meeting are generally the firms that have the highest brand perception, whether they're aggressively self marketing or not. And I think there's also a set of firms as Josh mentioned, like Altos and others that have fantastic performance and are less focused on that. But I do think for some of the big firms, one way to create relevance in a lot of content, have a ton of partners out there beat on the street, have a ton, ton of people meeting with founders and sort of feel omnipresent.

There's so many directions I want to go after that. But one thing back to the logo chasing and it just came up because I had a conversation with an LP friend of mine and she mentioned how it's so common for first time funds to put so much effort into portfolio construction and start like cherry Picking specific logos that almost fit outside their thesis that just showcase they can get into competitive deal. But the LP mentioned that's not your thesis. And I think even Josh and Jack said that it's fascinating that funds that want to raise, I don't know, their 6th, 7th, 8th fund. If they completely shifted the side of the fund they're raising on a track record from a model that they no longer operate out of.

I thought that was a really subtle but important point which is that there are funds that are raising multi billion dollar new funds to do entirely different activities but leveraging track records from an earlier era. I also just like Josh talking about his vision for I didn't know he had 50 people. Yeah, but just his vision for hey, how do you, if you're a boutique practitioner, how do you remain true to what you want to build in a world where everybody around you is raising more capital?

Yeah. And one thing he actually talked about was the presence of a non investing partner. I think they talked about with such a large reason why they've been able to keep the brand enduring as it is within first round. What are your thoughts on that?

The one thing I will think is that I've heard Josh talk about this at length is most firms don't think about their decision making process as a product. And if you thought about your decision making process as a product, you would spend a lot more time and care thinking about well how do we actually make decisions? And I'd argue in venture decision making is the product. Your portfolio is the sum total of the things that you saw, the things that you chose chose to invest in. And I think what he outlined, I don't think that will work for me. Like it's a little bit more rigor and we don't have as many decision makers at the firm. But I think a lot about on our end what is our product. And I think I'm happiest with our decision making process is individuals following their own intuition. And we write small enough checks to early stage companies that there isn't a lot of metadata to analyze. But I think it was Jack who said if most VCs looked at the way that their own firms were run and he had portfolio companies that were run that way, he'd be horrified because.

Being an adventure fund for most funds is lengthy discussions and discourse and bunning heads which is all really wonderful insights you can draw but then it's not recorded. I said double thinking on that because I think people would be interested to know within precursor how do we think about postmortems or reflections on inflection point for our companies.

He says, basically, memory is a crappy way to try to keep track of things. And I agree with you. The one thing I realized probably a few years ago was people would ask me, what did you think of that company? We invested. Inevitably, I had some rosy, overly optimistic view of how perfect the company was when we invested. And I was like, well, the only way I can think of to solve this hindsight bias is to actually capture your thoughts the moment. So now we have a whole process of, like, how do we capture at the time of wire, what do we think is going to happen? We do more as a documentation of what we think about the founders. And I find if you capture that in real time, it's the only way to be honest.

Yeah.

And then periodically, you want to update your thinking. So six months, I go, all right, I've been working with this company for six months. They've had a time to take the money we gave them and turn that into some insights. How effective has this company been? We asked the same or a very similar set of questions again. And for me, it's been revealing to see, were there things that I saw and or was worried about before we invested that have already shown up? And conversely, were there things I was worried about that appear not to be a problem?

Yeah. One of the things that I find is really great about our process, the ability to be honest about where we think our companies are, where I think a lot of funds don't want to put in writing where they think the right positions are. And I think it's a fear of where it could go or what if they're wrong? And I think back to Jack and Josh's whole point of if we could capture a lot of that information and learn from it. That's the most important part. So it does help you crystallize memories in a more formalized way.

It also helps other people learn from other people they can see, well, what did you think would happen? Oh, wow. You know, we have the terms of summer looking at a bunch of decisions we made, and they weren't part of those. So they can look at them as an outsider and say, well, these were the things you were worried about. Why did you do this? Anyway, I'm gonna happen.

One of my favorite comparisons in the entire episode was when they talked about the Hot Hand fallacy and talking about how, ironically, it doesn't apply to somebody like Steph Curry, who is paid tens of millions of dollars because he has a High percentage hit rate on the shot that he takes. It does very much apply to venture in most cases. Josh and Jack talked about how invest actually rewarded on the shots that they take, not the shots that they actually make. How do you think about that and vendor and get comfortable with that?

I'll never forget I met somebody, I won't say the firm who was at a firm that is associated as a seed investor with a bunch of really iconic companies. And we were doing one of these dinners where you introduce yourself and the person said we're investors in these three iconic companies and hundreds you've never heard of. That's pretty much true. And their whole brand is built on being associated with three really iconic companies. And nobody penalizes, criticizes or cares about the 99% of the investment. And I find LPs and founders are often the same way. They're like, well what's the best company you're in? Going back to this relevance thing, making a bunch of investment and being in market creates relevance. And every now and then I'll read some article, they're like I can't believe Andreessen or Sequoia invested in this stupid company. It's so dumb. And I'm like does it doesn't matter.

Also like you're talking about it, you're.

Talking about it, you're talking about it, you care. And if it doesn't work, it doesn't matter. I think it's quite interesting. Doesn't appear to be much of a long term penalty for being associated we work didn't work out with a lot of money kind of interesting. It's not like investing in WeWork was some stain.

It means you got to see the deal.

You got to see the deal and you were part of one of the more iconic companies of that time. I wouldn't make being a WeWork investor my whole personality. But there are people who've made single investments their whole personality and brand and they, they lean on that heavily. And my conclusion is there really is no substitute adventure for being associated with a winning company. And it almost doesn't really matter when you that involved. Like right now. I think if you can say I'm an investor in OpenAI, sure. People can say well when did you buy Animals and through spd it almost doesn't really matter. I don't know. I think about this a lot. The best LPs I meet tend to focus on what are you doing to get access to the truly special companies that matter and do you have access to Those and the LPs that meet that are less sophisticated and want to talk more about the average outcome for you. Like what's the average graduation rate? What's the. But this isn't. As Josh and Jeff mentioned, the average venture firm is not a good investment. The real question is show me that you have a history of being able to find outlier companies. Whether I've heard of those companies or not.

Yeah, I guess double clicking on that. How hard is that to do? Because I can imagine there's the fundamental difference maybe of what LPs deemed to be high quality pre seed deals and what you think they are. Especially when you're early on the fund and all we see are logos.

One thing I think about is for example, everyone talks about graduation rate. I'm like, what if you had 10% graduation rate but every company that graduated was a decacorn? I would rather have that than 50% graduation. But a lot of LPs would be like, oh well, 10% graduation, that's low. Well, it's not low. If you're looking for outliers, it's not low. The graduates are exceptional companies. I'm sympathetic to the plight of lps. They're looking at a bunch of funds and they're going to figure, well, how do I evaluate this person? Well, like in the absence of being able to underwrite portfolios at the company level, if I told you you have two choices. This fund has 10% of its companies that get the series A. This fund has 50% that get the series A knowing nothing about the underlying companies. You might say, oh, give me the person 50, I want to know more, I want to know more. But like on the servers you could be like, oh, show me the companies that have 50 or oh, this person has 20 companies in common with entry and this person has two. But what if the two that this person has are the two that are most important and the 20 that this person has are the 20 that don't work? You look, oh, on average this person co invests with the best people. Yeah, but a lot of this business comes down to specifics and I'm sympathetic to LPs who are trying to come up with these broad based heuristics. They will fail you. They will fail you in the same way that as a vc, if you like a broad based heuristic about what I'm looking for in founders, it will help you until it fails you.

Right now it's a glaring flag. If you're in all these deals with name brand funds and they're all the ones that didn't do well, like where were you for the deal that they did? Why didn't they move you in?

Right?

It always makes you ask the question like why am I seeing this?

There's an old Mart Suisser post that I send to people all the time and it's called why am I so lucky? And there are times I'm like, hey, if one of those big firms invites you into a deal and you don't have a relationship with them, it's worth asking why was I chosen?

I love that a portion of our job is supporting our portfolio companies in any way that they need, especially to graduate subsequent rounds. But I do find myself a couple times I can think of when an investor that I don't have a close relationship sends me the note and says this is a company that we've gotten a lot of inbound on and they're raising. And then I'm asking my question, why are you giving it to me? That's the case. And like I think about most similar companies who do get absolutely swarmed by inbound requests from investors. They're actively telling us please do not extend infros. And it's not to say they're there's a good or bad scenario, it's just something to observe.

Well, as you know, every quarter we send out this email to a couple hundred of our closest friends and we can see all of the intro requests quickly coalesce on a very small of the 300 companies are probably five that gets 75% and most of them I.

Would say are the ones that have the least amount of information attached to them.

The description it's always stealth. Yes, it is interesting to me just to see even within our own portfolio the gravity of attention towards the things that people think are going to work. We live in a world where I think in venture much comes really late. So I think people are always looking for a proxy signal. Graduation rates are a proxy signal. Co investors are a proxy signal. Founder backgrounds are a proxy signal. But they're all proxy signals. They're not signal in themselves.

One last question here is they did talk about secondary briefly but from the perspective of sometimes investors aren't as enthusiastic when their founders opt to take part in secondary mostly because they feel like I haven't got my money back. Why do you wanted your perspective on that?

I think there were two things about secondaries I thought about in that part of the episode. One is, you know, liquidity window in venture are irregular. A lot of years no money comes out. Then you get these broad aperture moments where you can sell everything and the door shut side.

We don't make money in venture in equilibrium.

I think about that a lot and I think part of the reason companies are staying private for so long is the development of a mature secondaries market. And I think everybody right now has an incentive to have a healthy mature secondary market. Secondary funds are like this is great, maybe before kind of get people to sell them secondaries politics. I think a lot of VCs before would say why would I do a secondary? This is one of my best companies, I'm going to take it public. And now that doesn't happen as much. So you can stay private longer because there's more secondary capital, which means as a founder you can get liquidity without going public. As an early stage venture fund like Predatorser, you can get liquidity either by selling to a secondary fund or to another buyer. And so I think all of these forces are conspiring. Push the circle of public date out for companies much later and then you know what's chicken and egg is that you need 3 to $500 million error to go public. If that's really the bar and it seems to be the bar that just take. But some of the companies that are still private are well beyond. And so my belief is that it doesn't matter what I think about secondaries, their gravity, they are just a part of the ecosystem now. Founders are going to take them, funds are going to be offered secondaries. This is a new feature adventure and I think one of the most dangerous things you can do in any business is to be too nostalgic for the past. I don't think we're going back to a world where companies are going to go public in seven or 10 years, hold only business. But Dodge also highlights and they kind of joke about this, but it's true. Sometimes something that goes to 8 will go to 80. And so I used to tell our LPs especially in 2020, the conditional probability to get into a billion dollar valuation once you got to a $100 million valuation in 2020 was quite high. If you got to a hundred, somebody was going to probably get you a billion. So in that world selling is crazy. You know that there's a high probability, there's another high mark coming. I think people laughed at OpenAI or maybe scoff more than laugh. And thus far every time you could buy OpenAI you get a markup in 12 to 18 months.

Going off to our next topic, Rohit Mittal, an early stage Startup investor and co founder wrote a LinkedIn post sharing a common but really difficult dilemma some founders face. What do you do when you're at 1.5 million in ARR with six months of Runway? Do you raise a down round or do you seek an acquisition? Rohit argues that both processes are demanding and usually exclusive. He encourages founders to honestly assess their energy and convection before choosing a path. If you want to choose M and A, you'll need at least two serious buyers. If you want a raise, you'll need to be transparent and fully commit. Either way, going in half in can destroy that optionality. So he's says that fundraising and M and A are both both my jobs. How have you been able to kind of advise founders when they've brought up some of these issues?

I think most founders think I can do both. You could probably not.

Well, yeah.

So one thing I asked, and this is very timely, because in Q1 of this year, I wrote Charlie Pete and said, I think this is going to be a big year of what I call the great realization. We're going to have a ton of companies. That realization is a double entendre. They won't realize their fate. And also we won't realize liquidity position. There's going to be a bunch of companies that wake up and say, I've been doing this for five years. We've achieved some level of. We are clearly not OpenAI or anthropic or cursor. We're not a breakout. What are we to. And your options are like, get profitable and continue to grind it out. Sell the company and partner with somebody else, or maybe wind it down and return some capital. I think for most of those companies, they're just not interesting enough to the Series A market to really fundraise. What I find is, you know, One of our LPs last week was like, well, why don't we get more of these companies to sell? You could try to make somebody sell. I haven't found that to be effective. Oftentimes what I see happen happens is people try to do both and then go all in on fundraising and say, well, if I can't fundraise, then I'll sell the business. And then they come in with two months of Runway and I go, okay, we can try to sell the company. Who are we going to sell to? They're like, oh, I was hoping you could help me with that. Okay, who do you know? Right? And they're like, well, I have a friend at Google. I'm like, don't we all Literally, don't y'? All? And oftentimes they tell them it's very hard to buy a stranger. Nobody knows your company. Nobody knows what you do. You're asking a lot of a product manager or, or core deaf person who's got a busy agenda and their own priorities to stop and make time for a company where they have no connection, where it's going to be a lot of their time and energy for not a lot of money. We have a lot of companies where I think in the end they're like, geez, I wish I had either started building relationships with potential buyers much earlier in our company's life cycle, or I wish all the time I wasted trying to Hail Mary fundraise. Like this weekend I talked to somebody, they have two months of Runway and they've got half of the round done. And they're like, we need cash. And I was like, I don't think anyone's going to give you money value in your current form. Too little Runway. It's too hard to financing. I think you could cut your burn and give yourself four to six months to operate, and maybe then we could help you raise money with a lower burn. But in your current form, the company is unfundable. And every year I get more comfortable just telling people, I think your company's unfundable in its current form. Here are the things that would have to change in terms of growth rate, spend for this company to be fundable. But right now it's unfundable and it's not a fun message to deliver.

Is there an advantage of sharing these types of options and offerings to them earlier on in the journey when it's not relevant? Or do you only share why it's feeling like it's heading that direction?

I think if you bring it up too early, some founders are like, oh, you don't believe in my company? I'm going to say, I'm like, what?

I said, right?

In other cases, you can bring it up, but what I found is I can tell a founder, hey, we have 18 months of cash. We should make sure we have a relationship with the companies that can someday be partners or buyers. And they're like, okay, and it's important, but it's not urgent. And urgent things crowded out. And then a year later, they're like, what do we have in a relationship with OpenAI or Google or Meta? I'm like, well, the time to start building, that was a little bit of. I'm like, guys, it's little things getting to know people in the org. If you're going to a conference where they're going to be there finding 50. This isn't, this doesn't have to be a sale. This is getting to know them, building touchpoint, having them get to know you. You get to know them so that if there is something to be done, there's a relationship.

Right. And they don't have to be along a journey while the software is being made the entire time. It's really just establishing a relationship. It doesn't have to be anything TR Transactional. What doesn't work or what doesn't feel natural is when you're rushing to do it. And then it becomes sales and uncomfortable for everyone involved.

And for most of these companies, it's just not worth it for the buyer to spend a lot of time and energy because it's a small transaction and it's a headache. And so you don't want to be a headache.

Yeah. Well, we are all out of time today. Thank you, Charles, for joining us in hot New York City this week. Thank you to our listeners for stopping by. Please like and subscribe and we'll talk with you you all next week. Thank you.