What VCs Say They Want vs. What They Actually Fund

Venture tends to move as a herd when it comes to interest in categories. And so if you want to get the maximum number of markups from the big Series A firms, you need to be making investments today that will be in categories that they will find interesting in the next 12 to 18 months, which right now means you should only be doing AI.

I mean this is something that happens all the time with Pre Seed is new funds come out every single year who have great competitive edge of being able to find founders. And so I find we definitely have our friends that we love to collaborate with. But I will say there's always new funds that introduce new founders and have interesting access.

I think what ends up happening is we anoint winners sometimes and people stop paying attention to the market and then things change and you come back five years later like, oh, I thought that company was going to win and then something changed and somebody came out of nowhere or somebody who had been working with a different thesis was ultimately proven right and you're like, who knew?

One trend I am seeing a lot for a large majority of these companies started by younger founders. And I wonder if this is a difference between what you saw in the 2000s is this massive social media and marketing presence. Oh yeah, which the article also talks about. Like I'm talking really flashy ads, loud and wildly colorful Instagram accounts dedicated to almost like meme content. And the purpose seems to be solely to grab the attention of users, whether it is for positive or negative reasons. I think they think about that value ad equally.

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 is a LinkedIn post written by Aditya Agarwal, GP at South Park Commons, who walks through two current modalities of competition when building in Silicon Valley today. So essentially archetypes of startups plus the spaces they choose to build in and the resulting competitive strategy. The first modality involves founders working on something legible, where success depends on out executing everyone else. These are spaces where what you're building isn't necessarily contrarian yet, but you'll face multiple competitors. The strategy here is to win as quickly as possible, with speed itself becoming the moat. The second modality is working on something completely illegible and contrarian. Aditya notes that some people should absolutely laugh at your approach and that's a good thing. The upside is that you can take more time in the early days to build thoughtfully and avoid prematurely drifting into modality 1. I have a few questions teed up here, but wanted to know how you felt about the post since it does echo a lot of our internal conversations we've been having on the team. Specifically, I feel like a lot of investors will say that they want to see modality two companies, these out there contrarian concepts, but really be creating more of a frenzy around modality one companies.

Oh yeah. I mean I really like this post because I've been thinking about, particularly with these AI companies, how do you think about which bucket you're in? And it feels to me that there's one pattern I'm observing over and over and I think about these companies on two dimensions. One dimension is the obviousness of the idea and we'll stick with AI. How, how obvious is the application of AI and how famous and well connected is the founder? And I meet people and I'm like okay, well my assumption is obvious ideas where AI can be applied are going to attract really well connected, well pedigreed founders who are gonna have lots of access to capital. So think about Bret Taylor at Sierra. I could name like a bunch of other companies where I'm like oh wow, that's a very well known founder going after a big what I would describe as obvious application of AI. So there's that model and that to me is like the world of big seed funds. And if you're going to do a big obvious problem like that, there's going to be a lot of competition, not just in number but they're going to be well capitalized competitors and you have to go into it knowing that that's the case. And it seems like right now for those modality one companies, the moat seems to be like your willingness to do996 and like the speed at which you can execute. I don't know that those are great moats, but it seems like those are the only ones people have expressed to me on a regular basis. And I think if you think about this two by two of how famous the founders are and how obvious the idea is, the companies that I think have the hardest time raising are the somewhat naive founders who are doing an obvious idea with no particular advantage in terms of expertise, insight or access to capital. I just assume unfortunately that many of those people are going to face far more competition than they realize, even if they don't know who those competitors are. And for me, the interesting companies are the ones where the founder doesn't have sort of off that access to capital and where the idea isn't intrinsically interesting or obvious or consensus good. And we do those companies all the time. And I find to your point, Mia, everyone's like, I want to see the things that are weird and wonderful and different. And then you show them and they're like, oh, but not that weird, not that weird, not that different. And so I think pick your problem. If you're modality one, it's brutal competition, you might have other people with very similar or inferior products who raise a lot more money, who are going to really, really make the landscape difficult. And not just the operating landscape, the fundraising landscape becomes difficult. Or you can have an idea where you work on it for a while, potentially in obscurity, where people don't get what you're doing, but with significantly less competition. And I think those modality two companies are great for first time founders because it gives you time to figure out the surface area of the problem and it gives you a chance to maybe learn how to operate a company without the like brutal pressure of competing in a hyper competitive market. And so I don't know, I'd say we do a lot of modality two companies. But I, I think the challenge as an investor is you don't get quick markups on those companies. You know, we have three astro witchy companies and in every case I've made one of those investments, people have like made fun of me and I'm very happy to be an investor in all three of those companies. But you have to be willing to sit with that weirdness for a while and it has to like not bother you. And I think there are some investors who, they want the good cocktail party conversation. They want to be in the hot deal or they want to be in the thing that sounds like intrinsically interesting to people.

Do you feel like there's a stage for those modality two companies that we've mentioned of which they suddenly become the cocktail party companies?

I think usually one of two things has to happen for that to be the case. One is something shifts in the macro and the thing that you're doing suddenly becomes way. You know, there were a lot of remote work tools before the pandemic, but the pandemic sort of shone a light on those and made those things really useful. Now some of those things went up and came right back down, but I think like that was a moment that took things that felt obscure and made them feel important. I think the other thing that happens is problems that people thought were small or uninteresting. It turns out that they are much larger and more interesting than initially understood to be.

I'm thinking about all the book companies too that we've been spending time with across our portfolio. I think if you weren't looking in those corners, you'd be like, this is a very small market and there's a cap on bookish people. I guess it depends where your fund is spending time. Question for you. I guess how different are these modalities today from modalities that you saw in, I guess like 10 years ago, 15 years ago, across venture? Have they changed change that much?

Yes, I think as the venture industry has gotten bigger, if you're going to do a modality one company, they're just going to be more competitors in the beginning because I think a lot of people are like, oh, this is a big obvious category. I want to have a play like we'll take an example like expense management. There were a ton of companies that were created there. Now it feels like Ramp and Brex have been the two on the startup side and maybe Navon on travel that have really broken out in the end. But like, there were a lot of experiments that were funded because it was a big category. And I think what you see is capital concentration around the perceived winners. I emphasize perceived winners because the, the customers decide in the end who really wins. And just the scale that the private winners can raise now is much bigger than it was 10 or 15 years ago. And I think also the pressure within Venture to anoint, declare or identify the winners earlier has gone up, which I think ironically is going to create a lot more false positives with people saying like, well, this is the one that's all lined up behind this company. I'm curious to see how that plays out.

And is the need to anoint these companies earlier coming from people wanting to validate the amount of money that's being put in them? Where is that need coming from from your perspective?

I think there's an investor desire sometime to just like sort out the market so that you can move on and spend time on other stuff. And if you're like, okay, we already know who's going to win in expense management, I don't have to spend any more time on that category. It's these three or four companies, they've raised all the money. The perception is they're going to win. That's a settled category. I can now go spend my time on other categories that are less settled. And I think especially if you're trying to put large amounts of money to work and you're trying to find category winners. Once you've identified the win, can kind of move on. And I think what ends up happening is we anoint winners sometimes and people stop paying attention to the market. And then things change and you come back five years later like, oh, I thought that company was going to win. You're like, oh, we all did. And then something changed and somebody came out of nowhere or somebody who had been working with a different thesis was ultimately proven right. And you're like, who knew?

Well, it's a good tale into our next topic. It's a piece from PitchBook written by Rosie Bradbury, who shares data that challenges the commonly held belief that VCs are independent thinkers. According to one PitchBook analysis, the top 20 US firms as ranked by PitchBook collaborated with at least one peer in that top 20 list in an average of 38% of their deals. That's nearly two out of every five deals. This figure has increased over the past few years, and there is a wide range in how inclined firms are to co invest, with some collaborating on as many as 55% of their deals, while others do so in just 19%. I think there's a lot of ways to interpret this data from specific strategies of funds wanting to syndicate deals together, growing fund sizes requiring larger owners ownership to growing round size requiring just more folks involved and more. Any other things that came to your mind looking at this data?

Yeah, I think there's two things when I look at the data. I was like, one, I was like, oh, I know specific people at that pair of funds who really like each other and enjoy working together. And I think it's important to remember that at least for now, this is a human business. Individuals are making the decision. And these are all firms where in addition to investing capital, you're going to take a board seat and you're going to work on this company for eight to 10 years. And I think a lot of people are like, I really care who else is around that table if I'm going to sign up and do that. And there are certain individuals at certain firms who have a real affinity for working with other people. And I think that shows up in the data. I think the other thing is taste. And I think a lot of the larger firms are essentially looking for the same types of companies and they're looking in the same places and they're looking for the same type of people. So it's not that surprising to me that they end up in the same companies because they're looking for the same things. I think the interesting thing is like to your point, as fund sizes increase it gets harder and harder to invest in the same route in the same company but also it becomes more imperative to get into the winners. So I think you will continue to see these companies where one firm was fortunate enough to win the deal at the A, somebody else comes in at the B. Because if you did the A, as much as you might want to hoard ownership, it is also nice to have a new person come in and price it and you know, as long as you can continue to maintain ownership and then you might have another really high profile firm come in at the C. Like I think a good example like this week was Clay we saw, you know GV came in and led the C and like they'd had some really good investors previously. And so I think again, again as you continue to see capital concentration in smaller number of names in venture, I think you're going to see more and more of the top firms needing or wanting to be on the cap tables of those companies and it's going to look like oh wow, how did Sequoia blah blah blah these five firms all end up even. Just look at Figma. Figma has most of the great venture firms on their cap table index, got in first and made the most money and others, Kleiner Sequoia also did fine too. But if you look at that cap table you're like wow, these are all blue chip top tier names co investing together. But the amount of money that they will make from those investments is a function of how early they got in and the total number of dollars they put to work.

For listeners who are checking out the reading, you'll see like an interesting heat graph that shows the percentage of collaboration from across these top 20 firms. I was thinking it would be interesting to see. I don't even think you could do this because I don't think the data is there. But basically that same heat graph applied to sub 300 million in AUM funds across the board because I mean this is something that happens all the time with Pre seed is new funds come out every single year who have great competitive edge of being able to find founders. And so I find we definitely have our friends that we love to collaborate with. But I will say there's always new funds that introduce new founders and have interesting access to deals. So that percentage is always shifting in our landscape.

Yeah and I think the big funds are in a much more zero sum competition world with each other than we are with other pre seed and seed funds and there's also just more companies. So I think it's more common. I find that, you know, we'll go on a run, but we'll do a bunch of investments with a given firm because we're meeting the same people at the same time and we have a some like, you know, I think about Bloomberg Beta, we do a ton with them. Yeah, I think it's because we tend to like the same type of founder, we tend to meet them at the same stage and there are other firms I'm like, I'd love to do more with, with those folks, but they're looking at a different founder profile than we are and it's less likely that we're going to, we're going to find the same things interesting.

The piece also included a quote from Kelly from sandana claiming that LPs do want to see that JEE LPs can see around the corner and have unique perspective and access that other fund managers don't. I feel like this is a widely discussed concept amongst vcs, especially in smaller fund manager circles that you want to illustrate access and relationship to funds that LPs clearly recognize on paper, while also showing the classic proprietary deal flow that makes their strategy unique. What seems to matter more from your perspective?

I think we live in a world where it takes 12 or 15 years to figure out if you've really made a great investment. I mean you look at Figma's first five years, that wasn't really that impressive in terms of observable external performance separate from management's execution. Same thing for Clay. The first few years were kind of like being in the woods from what I know from my friends who are involved in that company. I think most people's dream pitch would be I do all of these seed rounds and Sequoia and Andreessen do all of my ace. And there are, there are people who can credibly make that claim. I think about Romton at Abstract and other people people and I think that is an easy heuristic for LPs to understand because if the things that you fund early end up being interesting to those funds, on average, those big funds have very good judgment and see the whole market. So if they're picking your companies, you're doing something right. I think what's harder for LPs is if you're like, hey, I'm picking these great companies, but none of the people leading the A are firms that you know or have heard of. It doesn't mean that those companies aren't good. It just means that it takes more work to understand why they're interesting. And then the sort of reflexive question is if they're so great, why didn't one of the great multi stage firms do the A? And oftentimes there's a good reason why they didn't do it. They didn't find it interesting. The TAM wasn't that interesting to them in the moment. There can be lots of reasons why they don't do it. But I think if you want the easy path as a fund manager, it's to show that the companies you fund the next. I think if you're like, hey, we invest alongside these people all the time at the cda, then I don't think that's as compelling a story as like we're finding things that those folks find interesting later, but we're finding them first. First.

And I guess there is some, but not like a clear correlation of those funds jumping in, which means longevity wise, those companies will succeed. I'm thinking also about companies within our portfolio who found their series A investors as like family offices who are the best in class at this small niche area. That's extremely important in unlocking for a portfolio. If you were an lp, you would never recognize those names, but they're extremely important to the future success of the company because they have the expertise and entire verticalized supply chain knowledge on the exact spaces they're in. And so I would have probably picked that family office or that investor over a better known investor any day of the week because for the specific portfolio company, it's going to change the game for their long term success. But that's hard to storytell to LPs at scale.

I think it's super hard. And I think the other thing is, and I've seen this in our portfolio venture tends to move as a herd when it comes to interest in categories. And so if you want to get the maximum number of markups from the big series A firms, you need to be investments today that will be in categories that they will find interesting in the next 12 to 18 months, which right now means you should only be doing AI. But I don't think AI is the totality of where all of the interesting companies are being created at the moment, but it's where all of the energy is being focused. So if you have the bravery or naivete, whatever term you want to use to invest outside of AI, you have to accept that you're going to have companies that are going to be less interesting to big multi stage firms today because all of their energy and attention is focused on AI or defense tech or whatever, whatever the theme is of the market moment. I think you have to have the courage of a conviction that like if it's a good company, you will find somebody in the ecosystem who will also see in the company what you see if it executes well. And my experience at Precursor has been that's the case even when sectors are really out of favor. If the company's doing really well, you can find somebody who believes in that company. And I think about like all the consumer fintech companies that kind of had a really rough go in 21. That category is kind of back now.

Yeah.

And if you were able to ride it out as a company and continued up right. Competition went down, capital was hard to get, those businesses probably got better and now people are open to looking at those again.

Our last topic of the week is a good one. It's a piece from the New York times titled the 20 somethings are swarming San Francisco's AI boom, talking about the massive wave of young talent flocking to the Bay Area to start their AI companies. Companies like Scale, AI, Cognition, Cursor, all started by young college aged founders are examples of what success looks like for most of today's college students. With some folks rushing in right after they graduate. There are some founders who are even in their teens both building and getting fund by large venture capital funds for folks who dropped out of their undergraduate colleges. Their argument was simply around the fact that they couldn't afford to not take advantage of the opportunity that is building in today's AI market. One notable quote from an undergraduate Stanford student was quote it's kind of this AI inflection point where it felt like almost everyone I knew at Stanford was dropping out to co found a company. Charles, I wanted to get your honest opinion about this massive wave of younger founders opening up shop in SF and also see if it resembled any sort of boom during the 2000s or does this feel feel palpably different?

No, it feels the same. The funny thing is Marina and I were talking about this earlier this week because I was a college student during the Internet 1.0 boom at Stanford and my classmates were dropping out of school to start companies. I lived in a house with a bunch of guys and we thought about dropping out of school to start a company and we decided not to do it. We had eight co founders, we had over six co. It was, it would, it wouldn't have worked for a bunch of reasons, but there were people in my class who did decide to drop out, including some of my very good friends, to pursue ideas that they were excited about. And the logic was the same. It was like, hey, this Internet thing is happening. This feels like a once in a lifetime boom and if I stay in school, I'm going to miss my window. And my sense as an undergrad was this was even more pronounced at the business school, at the gsb, like, it was even more pronounced. People were dropping out to start companies and on average none of those companies mattered. You could say, oh, Mark Zuckerberg at Facebook. Of course there are examples of like, where this worked out. On average, most of the people, well, I know the thing they dropped out of school to do did not turn out to be Yahoo, Facebook, Google. That doesn't mean it wasn't a great experience for them to raise money and try out. Most of many of those people have become life lifelong entrepreneurs as a result. And I think I feel really awkward saying this, but I'll say it anyway. I think some of these people, these, these entrepreneur students are also being like ruthlessly cynical and they're like, listen, it's not as important that I graduate from Stanford as it is that I got in in the first place. Some of my friends who dropped out to do startups eventually came back and their degrees graduated. Others were just like, I got in and I attended and I didn't get kicked out, I dropped out. Being a Stanford dropout is not a huge liability if I'm pursuing a career in venture capital now, if I want to like try a startup and then maybe go into consulting, maybe the stigma of being having not completed your degree, I mean, you would know better than I would about like that world. But my hunch is there are worlds where it's a stigma, but not an entrepreneurship. Ironically. And I think this ties back to some of these articles about these really entrepreneurial students being mad that they weren't accepted by top colleges. I'm like, well, maybe the top colleges read your essays and also concluded you weren't really coming there to learn, you were coming there to start a company. And they're not incubators or startup studios or universities. And so I hope that many of these people are more successful than the late 90s entrepreneurs were who dropped out and started companies. And I hope for many of these people that they discover entrepreneurship as a lifelong career path. I also worry that some of them are going to miss out on a really amazing social and developmental experience. For a lot of people I know, including myself, a lot of Your maturation starts in college. You're on your own, you're outside of your house, you're meeting new people. You kind of only get a chance to do that once.

Yeah.

And I hope these people aren't making a trade that they someday regret.

Yeah.

Also like the Valley has always been obsessed with like young wunderkind geniuses.

And like that's not new.

That's not new.

Me and Marina talk about it a lot too. Mark Zuckerberg is an anomaly. Alexander Wang, anomaly. Yes, they are young, but that's only a small factor of why they are wonderful founders. And I think sometimes people are confusing, I guess being young with being successful and excited and again, I mean really wonderful and very impressive young founders all the time. I do think about and I do wonder what things will you miss out on if you do drop out of school for the wrong reasons. So to your point, if a lifelong career in entrepreneurship is what you would like to do, then I can more so understand it. One trend I am seeing a lot for a large majority of these companies started by younger founders and I wonder if this is a difference between what you saw in the 2000s is this massive social media and marketing presence which the article also talks about. Like I'm talking really flashy ads, loud and wildly colorful Instagram accounts dedicated to almost like meme content and the purpose seems to be solely to grab the attention of users. Whether it is for positive or negative reasons. I think they think about that value add equally. Any thoughts on how this feels different from generations prior? I do think a lot of this has to do with AI or like a grab for customers is extremely important in the beginning. So having this sort of virality on the platforms that already exist, because those rails exist today is available.

I, I think cluly is probably the big example I can think of. I think the ability to break out from the noise of AI and this the din of startup creed, like people who can break out from that noise, that is a skill. And I think a lot of investors say the group of people who can do that have probably a good chance at succeeding. When it comes to distribution and gtm, that's a big problem, especially in a world where a lot of these products feel commoditized or similar people who can make a marketing splash. I mean it's obviously it's different because we didn't have this stuff 25 years ago. Like these channels didn't exist and it was more like the whisper reputation network. Oh, this person in our class is going to be a Good founder that somehow bubbled its way back up to Kleiner Perkins or whatever venture firm. That was kind of more of how it worked. There was no harmonic, there were no tools to mine Twitter. But I also think some of these founders have gotten smart and they know well like VCs are looking for these signals on Twitter or TikTok wherever. So if I create these signals, I will be found, which is separate from whether or not I'm creating anything of value or of interest. So I think we have this feedback loop where founders now understand that creating content, creating signal creates the opportunity to get the attention of investors. And that attention of investors gives you the chance to, to get in front of them. And I think we're going to continue to see people who fund them. I think like, you know, the dollar shave Club ad was like a big breakthrough moment at a certain period of time on the Internet. You have these flashpoint things that happen and then, then you get. People are like, oh, I want to copy that too. And I'm like, it kind of works for a bunch of reasons that are.

Hard to recreate, like Godaddy, Orbeez, et cetera, any other sort of viral moments. And it also feels like this younger group of founders is driving the rebirth of 96 culture too, which also is not new like that that existed in the 2000s. I think I'm trying to figure out 996 like works for younger generations. Why would you not want to be around the people that you work with all day, that you are like minded with, that you're excited to create with? Again, like all more things that I'm excited to watch and again, hopeful that people are in it for the right reasons. And then I also hope that VCs are also exploring relationships with those young founders for the right reasons as well. I think about a lot.

The last piece is the one that gives me a little ick, which is I worry about encouraging people to drop out. My view is like if you've been building something and it's starting to get momentum and you're like, I'm having a hard time keeping up with school and keeping up with my startup. That's a different framing than I want to drop out of school to do a startup that has no momentum, that's an idea and I want to be able to work on it. To me that's like a very different calculus. And I worry that I've met some people who've been encouraging people to drop out and I'm like, that person's not yet at a place with that idea or business where more time spent on it is going to accelerate progress.

And, like, asking the investors, are you prepared to be their safety net for some of those kids who do not have any financial safety net.

Yeah.

And worked all their life to get to X, Y and Z's college. And that's the pinnacle for their entire family's generation of seeing their child be there. So I'm having more conversations about that with our friends and always curious to kind of see their different perspectives. We are all out of time today. Thank you, Charles, for stopping in. We are taking the week off next week, but we will be back the following thank you to all of our listeners for jumping in. Please like and subscribe. And we will talk with you all in a couple weeks. Thank you.

Bye.