The Revenue Metrics Conversation Every Founder Needs to Have Before Talking to Investors

When you're in a very competitive environment, standards go down. We saw that in the mortgage crisis. I think we saw that in 2021. I think we're seeing a version of that right now too, which is that I think people want to get into hot AI deals. And if a company gives you a revenue number that looks passably accurate, if you're the person who really digs in, you might not get the deal. In the long run, that might be the optimal thing, is to actually not get the deal. In the short run, that is not what people want.

It's the week of April 27th. 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. Our first piece this week is a post on X by Lukas Voss titled The Narrow Path, talking about what is actually happening to seed investing right now. The core argument is that the venture ecosystem has split into two completely different games, a top tier where the best founders raise at $40 to $100 million post-money from brand name funds, and everything else, which which Lukas calls a capital black hole, where money goes in but paths to liquidity are nearly nonexistent. He uses a data point to anchor the whole piece, that the original angel investors in OpenAI put in roughly $10 million collectively and are sitting on about $1.4 billion in paper value today, which sounds great until you see that it's only a 140x return on perhaps the most consequential company of the decade, and that the traditional seed model simply cannot survive if the biggest winner of the era only returns your fund 1.4x. His prescription is a direct challenge to the conventional that smaller fund size should drive lower entry prices and more diversification. Position concentration, he says, matters far more than ownership percentage. You have to be willing to pay up for quality, and picking has always been the job. The industry just spent a decade building models that disguised it. I read this piece and found a lot of the takeaways genuinely insightful, and I know we just talked about it together like 5 minutes ago before we started recording, but I'm not sure fully that I buy the argument that seed as a construct is the problem. There are deals happening today with structures that we've never seen before that are changing what the outcomes look like for that stage. Wanted to pause for your thoughts on this one, Charles.

Yeah, I think Luca's article definitely made the rounds in a bunch of GP group chats that I'm in. Whenever you touch on like what works in seed, you're going to get a lot of attention and reaction from folks. I read the post and a couple things. I don't think we always know what the big outlier outcomes are going to look like. I think about. Grunz, like that was not a company that most people had on their bingo card. And so I think seed is, for me, if you zoom out of all of this stuff, seed is supposed to be a really high multiple, high risk, high return part of the venture asset class, which to me means you should be able to get multi-hundred X returns on your single company winning positions on first check. Now, if you put more money in, of course, the, it's likely that the aggregate return will come down. I think seed is very challenged for dedicated seed managers, but I think you have to go back to this other point about bifurcation, which is there are some people for whom seed is not their core business and making money on seed is a necessary but not sufficient thing, or it's maybe sufficient but not necessary. Actually, if being a player in seed gives them visibility into the market, allows them to see what people are working on, informs some of the checks they— the big checks they write at Series B or C, and the price to acquire that information is a relatively de minimis part of your AUM, that's a very different strategy. And I think really you have two different games you can play in seed right now. One game is invest in the hottest, buzziest consensus stuff and hope that despite the high prices, that on exit you're still happy with the multiple. We simply don't know if that strategy works at scale. It works if you're Wiz. We know that, like if you do $100 million and get it at $23 billion, that works. I think there's no question that that works. The question with those is like, how representative are the outliers of the average? And I think by very nature of calling them outliers, I think kind of answers the question to some extent. The question is, is seed a good business to be in as an investor if on average you're paying high prices, but on average you're not getting outlier exits? Well, it's not a bad business, but you're also probably not a good picker. And so for me, the question is like, if you're going to do the high consensus deals that are expensive, they have to be extraordinary outliers and you have to find a way to get enough of those companies that matters. But the truth is, you know, 11 people can't own 10% of a company. The math simply doesn't support it. And so I think that's the challenge with that strategy. Other strategy, which I think is closer to what we do, is if you pick things that are maybe less sought after initially, you have follow-on fundraising risk, or you have the cocktail party risk where you're in a bunch of companies that you tell people that you're an investor and they look at you blankly and say, I've never heard of those companies and I have no idea why you'd want to invest in them. So to the extent that people thought seed was easy, I hope that this post disabuses them of that notion. And I think seed is hard. You have to pick really well and you have to own enough of the companies that you choose. And part of this is seed funds have gotten bigger, which means owning enough in quotes has become even more important because the scale of of the fund and the amount that a winner needs to return has gone up. I think we talked about this before with Micah's post. It's a really bad idea to apply like seed math to a Series A fund. They're, they're designed to do different things. And if seed becomes buying big chunks of these companies at high prices and you lose the ability to get the really high multiples, I'm not sure it's the same business.

And if you're more of like a tourist in seed and you make most of your money and alpha in other stages, then I imagine that maybe the point of participating seed also maybe is not for all of the returns. It's all about having a pick for what's coming up and then being able to push in more capital in larger quantities in later rounds.

I think the biggest bifurcation I see in the market right now is what chunk of venture returns are going to come from consensus deals that are born consensus hot. And I think all of the structural incentives as a fund manager are to pile into consensus hot deals. Because if you do 10 deals with the big multistage funds, when you go out to go raise your next fund, you will probably have markups and you will probably be able to say, hey, I'm in 10 deals with these great firms that, you know, that has nothing to do with company quality. But in the short term, if you're trying to fundraise or you want to be cool, like that's a very good strategy to pursue. But in the end, it doesn't mean that you're going to actually make any money on those companies. But I think there's a lot of people who've said, oh, well, this has worked in spurts before, so maybe this is the new way to play seed. I'm like, but maybe not.

He kind of makes this claim that the era of easy, low-priced, diversified venture investing is over. I think that only makes sense if you believe that just because you're coming in low price, it means that you have no downside to everything and you can kind of just pick a bunch of things in a range of price. You still have to pick.

Yeah.

Even if things are at 5 post, that's just part of the game.

There's a sub-argument in here that I read and I'm like, maybe I'm the only person who thinks this. If the belief is that the blue-chip assets are obvious and knowable at seed, you don't actually need seed funds. You don't need them. I think if you're like, yes, if we know at seed all of the companies that will matter, then the only strategy that's worth pursuing is to get into those companies and buy as much as you possibly can. I just reject the premise.

We've just also seen it work in other ways too.

Yeah.

If we didn't see it working, then I think you would have fewer data points to make that argument. But, but we do. Our next good read is a post on X from Gary Tan, CEO of Y Combinator, sharing YC's official guidance on being truthful and precise about revenue metrics. The crux of his message, that non-binding LOIs, GMV, bookings, and contracted ARR, transactional revenue, And true monthly or annual recurring revenue are all completely different things and should never be used interchangeably. Gary is direct that this is not just a communication preference. It is a matter of trust with investors and founders who blur these lines, even accidentally creating real problems for themselves down the road. The post reads almost like a field guide. It's ranked from least to most impressive with the explicit callout that annual revenue run rate should never be abbreviated as ARR and CRR. ARR means something specific and recurring. There was a lot of discourse in the comments if you looked in X that the fact these were written out was offensive to founders, and there was a lot of finger pointing to investors and media players for creating an ecosystem where founders feel like they have to become creative with their metrics in order to stand out. Wanted to hear your thoughts on this all.

First of all, I'm glad they wrote this because YC saying it is authoritative. And people will pay attention. I'm embarrassed for our industry that this needs to be written. And these are not judgment calls.

Yeah.

These are terms that have specific meaning and have had specific meaning for a long time. And we shouldn't even have to have this conversation. Yet here we are. A lot of the comments are like, well, whose fault is it? I'm like, well, it's everyone's fault. I think there are some founders who are not as well steeped in math and in the meaning of these terms, in some cases who might've genuinely gotten them wrong. I think the AI hype cycle has made really vertical revenue the sort of lingua franca if you want to get media attention or investor attention. And we talked about this maybe a year ago. The predictable outcome is that people were going to try to find a way to fudge, shape, or present their numbers in such a way that they can fit under whatever the high-growth scenario umbrella is at the time, just so that they can get considered. Some founders I've talked to are like, well, investors are smart enough to know. To see through this once they get in there. But if I don't have high growth, I don't get the meeting. And I think some investors are like, yes, I am smart enough to see through this, but this is a high-growth company. If I push hard and due diligence and I don't get in and it continues to go up, I was like morally or intellectually right. And I didn't get into a deal that matters. And plus every other company out there is maybe engaging in similar shenanigans. And you end up with a system where like nobody wanted to pull the combine cord and say, hey, let's just stop this. I don't know that this will change much, but at least it creates the ability to have a conversation about like, what do these numbers actually mean? And I think a lot of investors were aware that founders were calling ARR was maybe contracted ARR, but not deployed ARR, or maybe it was services revenue from forward deployed. I don't think investors were like being duped or naive. I think founders might've been in some cases. I think it's bad for communication industry when revenue and ARR don't mean the same thing to everybody.

I've had tons of conversations with founders where it's certainly not malicious, but I mean, it's now become, and it should have always been part of practice to ask additional questions when you mean contracted ARR. What's the length of the contract? Is it a month-long contract or is it a multi-year contract? Contracts right now in today's AI age have completely changed in language. Most of them are like actually pilots, but you call them contracts so that you can put it into contracted ARR language and they have kill clauses and no re-ups involved. So it does muddy the water, but as investors, you should always be double-clicking, but so early gone, you would've thought it's not as murky as before.

I think when you're in a very competitive environment, standards go down. I think we saw that in the mortgage crisis, standards went down. I think we saw that in 2021. I think we're seeing a version of that right now too, which is that I think people want to get into hot AI deals. And if a company gives you a revenue number that looks passably accurate, if you're the person who really digs in, you might not get the deal. And in the long run, that might be the optimal thing is to actually not get the deal. In the short run, that is not what people want.

One thing I was thinking about the other day is we mentioned in this piece, investors are implicated here, founders are implicated here. You know, how much do you think imprecise revenue language actually ends up hurting founders and our teams internally? Like how they track their own progress and goals for their internal team. If you're like an employee number 3, 4, 5, like you're the first sales hire, like what happens there? Or do you think oftentimes you're too far removed that those things don't actually trickle down in front of you?

What ends up happening, I've seen this happen, this is one, this is one archetype. A company hears about somebody else's revenue number and says, how on earth are they doing that? We're so behind. And then you have a board meeting and someone goes, Company X is doing $100 million in ARR and we're at $10. We're so behind. How is this possible? And there's all this like kvitzing and like strategy meetings and how are we going to grow faster? It turns out that company is only doing $15 million in true ARR. And you're like, okay, so we weren't even behind. Freaked ourselves out, tried all these crazy things to grow faster because we thought we were behind, but we weren't. But part of the problem is, you know, if you are the perceived winner and capital flows to you based on, we'll say, misunderstood metrics, there's no takebacks. There are some. There are relatively few takebacks. And then the question is like, what do you do if your competitor used misunderstood metrics to raise a bunch of money and put distance between you and them? I think that's hard. So I think almost everybody has an incentive to keep going.

I had a conversation with one of our teams a couple weeks ago. We like sat for an hour to look across their financials. And one thing that I saw that came through in an investor update is there was so much volatility month over month in how they were reporting their revenue. And I was like, ooh, this is a problem. We walk into the meeting and I bring it up. There was a steep decline here from like month over month. They're like, oh, we bill quarterly, so it doesn't come out even. So like this $40K drop from February to March actually wasn't somebody churning. It's just the way you bill. They're like, yeah. I'm like, oh, these are things that we need to just tweak in language to make sure everyone understands is on the same page. Because I think one thing that founders don't realize is If a net new investor saw that, you'd pass immediately, or you'd be like, there's something weird going on here. I'm not interested. Even though it's not the fault of the founder. And if the founder massaged the numbers to meet them halfway, I think an investor would also be like, well, you're kind of tweaking the numbers here. That's actually not how you built. We had an hour-long conversation basically of when we come up for the next raise, how do we want to talk about this? Because you guys have amazing traction and I don't want it to get lost in somebody thinking that you're portraying it where it's not actually as great when like it truly is. And I think that's actually the conversation that most founders live in from time to time.

Well, I think, but I also think most founders are like, I want to get a meeting so I can get into the room and tell somebody. And I have VCs who are just like, oh, the growth in that blurb is too slow. I don't want to meet the company.

Right.

Of course the company's going to be like, well, if revenue growth or revenue run rate is what gets me in the door, I want my company to be presented in the best light possible. So people will take the meeting and then hopefully I can dazzle them with my like winning personality and like amazing story. But if I can't get in the door because I'm growing at 75% year over year and everyone else is advertising 500% growth or 1,000% growth, people aren't going to take the meeting.

But wouldn't you argue that if you get into a tough situation coming into the meeting and then the founder's like, ooh, I found something weird, you're in the hole already. There's no back and forth of like, oh, let's hop on the phone and walk through like how we have a discrepancy of $1 million in ARR difference here. Like you're in the hole already, which is a bummer.

I think most people are like, like, just get me in the room. I'll do whatever I have to do to get in the room.

Which is also things that investors say about trying to get into hot deals, I will say also. Our last piece this week is a TechCrunch report from the past weekend. China has blocked Meta's proposed $2 billion acquisition of Manus AI after a months-long government review. Manus is a Chinese-developed, now Singaporean-based autonomous AI agent that went viral earlier this year for its ability to perform complex multi-step tasks without human input at each step. and the deal would've been one of the most significant acquisitions of a Chinese AI company by a US tech giant to date. Regulators blocked it on national security and data sovereignty grounds. What makes this one worth discussing is the broader signal it sends as Accenture AI moves from interesting demo to genuinely strategic infrastructure. The geopolitical walls around it are going up pretty fast, and the window for cross-border AI M&A may be closing in real time. This does feel like a preview of a much bigger dynamic. It's just being treated more as strategic national infrastructure like I mentioned before, and not just as this standalone product that people are excited to make money off of. How do you think about what that means for the investment landscape around AI companies that have meaningful exposure to one side of this geopolitical divide?

I was very surprised when this deal happened that everybody assumed it would go through. And I think ironically, most people are like, well, the US is going to allow this to happen. I was like, but don't the Chinese regulators have a voice?

Of course the US will allow that. Of course.

And, you know, I think when all the CFIUS and reverse CFIUS stuff started to happen, I think a lot of people looked at, you know, Singapore, Washington, or how can we still get access to the amazing innovation and technological development that's happening in China without having to deal with the regulatory environment? I'm like, guys, those regulatory environments exist because of great power competition between the United States and China. First of all, I feel really bad for the people who are involved in this transaction.

I think they all thought it was a done deal, including the employees who were sitting at Meta.

And to me, we just live in a world where technology is part of national security and companies view technology as part of their national interest. And I think it just increases the riskiness of any cross-border deal and not just any cross-border deal. I think about Adobe, like other deals where the company is a global player combining with another meaningful or significant company is going to invite regulatory scrutiny, even in jurisdictions where you might say these people have no standing. To even make an argument. And technology is global and it touches some of the most important things in the world. And so I think this is the world we live in now, which is that whether it's semiconductors or AI or defense or energy tech, I think a lot of these things are going to face multi-party regulatory scrutiny when it comes to M&A or general business strategy.

I was going to ask you, did this Block deal change how you think about the exit landscape for AI companies that have any interest? International complexity on their cap table, or I feel like you've thought this way probably consistently.

I think every government thinks that they have a national interest in AI in some element of it. And the notion that companies were going to be able to either skirt regulation by doing clever domicile stuff or that like other regulators weren't going to weigh in, I thought, well, that seems a little self-serving. That's not the world we're in. Maybe if we get back at some point to a place where there's like less great power competition, a greater sense of collaboration at the international scale, some of this stuff would maybe be less heady, but not anytime soon.

We are all out of time today. Thank you, Charles Hudson Hudson, for jumping in. Thank you to our listeners for joining as well. Please like and subscribe, and we will talk with you all next week. Thank you.

Bye.