Episode #16: Pre-Seed/Seed M&A, Solo Founders, Harvey $3B Raise, Fund Performance Recalibrations

The lesson I learned in 23 and 24 is if you're conservative in a world where the people evaluating you think everybody else is optimistic, you get treated like the optimistic people. And whatever you do that's conservative will still get discounted because it's too hard to tell who's truly conservative and who's an optimist masquerading as a conservative person.

It's the week of January 20th. 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 two pieces are great snapshots from Peter Walker and the Carta team. The first is around M and A Activity and Venture, where Walker's data showed that half of startup M and a in 2024 was at the pre seed and seed stages. The the post emphasizes how changing market conditions are pushing companies to seek growth through acquisitions, particularly as organic growth becomes harder to achieve in a cautious funding environment. What's interesting is the blend of motivations. Some startups are looking for exits as fundraising gets harder, while larger companies are leveraging cash reserves to secure talent or possibly fill gaps in their product offerings. So while the increase in M and A deal activity is exciting, it's impossible to not acknowledge the reality that valuations were largely bubbled over the last handful of years. So so it's not clear if these acquisitions resulted in tremendous earnings for founders and their investors across the board. So Charles, Pre Seed and Seed is our investment stage here at Precursor, and we're constantly tracking M and A activity across our portfolio of 400 plus companies across every industry every week. I was curious if you felt in comparison to years prior, has there been this uptick in M and A interest and movement over the year? And what does that tell you about the current state of venture?

If I look at our M and A tracker, you know we go over it every week as a team. There's certainly more companies on that list. And I think what's happening happening is we've gone back to something that feels like an earlier era. I think from 2018 maybe to 2022 there was just a lot of insider support for companies that had made good progress but not great progress and maybe got pretty far down the line on a seed round. But it didn't happen. And I think a lot of insiders just felt like, well, we'll bridge These companies, we'll extend them, we'll keep them going because they're one or two quarters away from being ready for whatever arbitrary name of round they're trying to close, whether that's a series A or a seed two. And I think when we had the big valuation res in 2022, I think a lot of VCs looked up and said maybe we shouldn't continue to do these bridges and extensions. Maybe the series A bar has gotten so high or so hard to predict that the right answer actually is to cut our losses. And for the companies that aren't working, instead of extending them and giving them more time, we should more aggressively encourage them to sell. And I certainly have noticed on the group chats and investor only threads I'm on with companies where I'm an investor, there are many people who are pulling that lever much sooner. You know, six, nine months of Runway companies starting to talk about a bridge. A lot more, hey, let's run parallel process. Let's look at selling the company. Let's also think about a bridge. And I think founders have gotten that message, which is that there's going to be some resistance if you ask for a bridge or an extension or you want to keep going and you're relying only on your insiders. And so a lot of companies are selling. And what I'm typically seeing is these deals are okay for everybody. Usually the founders get jobs. I also think part of this is just the labor market. I think previously the funding markets were so good that if your company didn't work out, a lot of people were like, well, I'll go start another company or I'll go get a job at a big Fang company or the list of options felt pretty robust. And now it doesn't. It doesn't feel like Fang is safe. It doesn't feel like it's easy to just walk across the street and start a new company. And I think more people are saying, hey, if I land this plane and we get Aqua hires a small deal, is there a job on the other side of this for me, at least for the next year? And so I think some of this is happening because founders, I think, are getting the sense that investors are less likely to support them. And I think some of this is happening is because investors are pushing companies that aren't clearly working to sell, shut down, return capital or pursue exits, even if those exits don't generate a lot of money for anybody.

Precede. And seed is also very early in the journey. So I was not surprised because I've seen the data across precursor of when we start engaging on M and A activity across the board. But for people who invest in other stages, I think maybe that would be a new insight that so much of this activity happens so early on when maybe product market fit hasn't quite been reached and it's not really a conversation around let's try another angle but maybe it's time to think about other routes entirely.

A lot of these things end up being relationship driven too. Like I tell our founders, like nobody buys a stranger and at this stage a lot of times the founder of the acquiring company knows the founder or team of the company they're acquiring and wants to add that. And so I will say like very few of these acquisitions, the ones at least I'm seeing are like, wow, pre seed company has built some amazing pieces of technology and there are people fighting to acquire the company. It is much more like hey, we tried something, we learned something, it's working pretty well. Maybe not well enough to keep going, but there's some value here and in most cases what you're getting is either your money back as an investor and or some stock in the company that acquires it and you hope that that company does well.

The second piece from the Carta team was a graphic indicating that stuff Solo founder startups are less likely to receive funding Solo founder startups are 35% of all startups, but 12% of unicorns from the past year. This all being said, this was actually an increase from 29% in 2023, indicating that more founders are opting for a solo journey. The founder journey is obviously extremely difficult, and there is an argument that bringing along a partner for that journey offers a strong sounding board. A partner in the trenches, et cetera, et cetera. However, the flip side of that is that the wrong combination of founders can lead to a company's demise. Within our own portfolio, roughly 23.5% of our companies, both inactive and active, were and are led by solo founders. So I was curious to ask, how do you evaluate that when we think.

About team dynamics, I would rather have a committed, focused solo founder who's passionate about what they're building than two people where one is only half in. I always think about like but what are the ideal configurations? I think the ideal configuration is two deeply committed founders just because being a solo founder is really hard on your down day because there there isn't a person there to counterbalance, there isn't a person to hand things off to. And also Mia like I don't know, when I started Inventure 20 years ago, a founder was somebody who was there the day the company started. And now a founder is a title. We have people who have these late joining co founders who join companies a year to three years in and are given the founder title as an honorific to recognize their contributions and to make them feel empowered, but not because they were there from the beginning. And I used to be very resistant to this because I was like, it dilutes the meaning of what it means to be a founder. And I've totally come around and said, like, this is like head of, this is like all of the other titular innovations we have in startup land to recognize people's contributions and make them feel seen and recognized in their role. So now to me, a solo founder is a company where one founder owns 85 or 90% or more of the equity. And the number of times in the last five years I've met a founding team where I'm like, this is a founding team. There is a founder and two people who joined this person very early. And whether they have the founder title or not, the equity is held in the hands of a single person. So now, now when I meet teams and as you know, it's part of our intake process, I'm like, show me the cap table and show me who owns what, because that will give me a sense of like, who's really central in the journey and maybe who was given a co founder title because they wanted the recognition. So my biggest fear with solo founders is not that the person isn't, is, you know, is a bad leader. It's just like, maybe you're on your own because you can't work well with others. And so I'm always trying to test, is this someone who just, hey, had an idea, nobody in their ecosystem or orbit was ready to go on the journey with them and rather than wait for that person, they got started, or is someone who can't share their Legos, who can't, like, play nice with others, who can't recruit, who has some defect that will make it hard for them to build and scale the company. And if I think it's the latter, I usually won't invest. But in most cases, I think it would be weird to sit around if you had a good idea and just look for or wait for somebody else to start. Unless you're a person who's really committed to this, says the guy who started a solo GP fund and is still the only GP 10 years later. So, you know, I may be guilty of Motivated reasoning. But some of our top companies have either wildly imbalanced cap tables or are essentially solo founders. And I think when it works, it works.

When you're kind of discerning between those last two scenarios, one of which being the founder who maybe can't play nice with others. How do you figure out signs here and there?

I'll usually just ask them, did you think about having a co founder? Like, did you explore this process with anybody? I'll try to look at other places or organizations they've been a part of. Were there signs in those companies that the person couldn't grow? And you know, sometimes I'll meet people who've had three or four one and two person companies and I'm just like, maybe, maybe this is a sign that nothing you've done has ever scaled beyond one or two. Maybe that's like your comfort zone and preference. Maybe that's the limitations of your ability, or maybe it's just circumstance. But it's probably worth having a conversation or two to figure that out.

What are the specific learnings that we've had about co founders that break up throughout the journey, and what does it take to be successful for founders who started as a duo and then continue on solo and choose to kind of go on that journey on their own? I know we track a lot of that information over time.

My big learnings are for the first five years of the fund, I kind of only looked at what I call the principal founder, the person who was the CEO and had most of the equity. And if I liked that person and didn't love their co founder, I would probably invest because I was like, as long as this person's here, I feel pretty good about our investment. And that really worked. Then we went through a period of time where we had a bunch of breakups and I was like, oh, in many cases, like I. If I'm honest, I wasn't as enthusiastic about the second person. And usually there's a couple of archetypes. One is if the founder's technical but not that sophisticated and not a people manager, I'm like, well, at some point we're going to need a stronger technologist leading the company. And that puts that technical co founder in an awkward place. If they're not technical enough to be the system architect and they're not people oriented enough to do the VP of engineering, there's really no place for them. It's hard to make the co founder an individual contributor in the nj. Org is just awkward sometimes. You know, we do a lot of forecasting with the hope that people are going to grow into what the company needs. And sometimes people just can't scale with their own companies and the company needs a different leader. Sometimes it's health or life circumstances, divorce, death, kid issue. And the ones that are the hardest is sometimes people just run out of energy. It's been five, six, seven years and they're just tired and they've given it all they have and they need a new challenge and they leave. So my assumption is that it's highly unlikely in a world where it takes 10 or 15 years for companies companies to fully mature that everybody who's there at the start will be there at the finish. I was talking to someone about this over the weekend who has a co founder who left that. I asked the person like what did, what did we lose? With this person out of the building, what, what did we lose?

Our next article is from Bloomberg titled Legal AI Startup Harvey Set to Double Valuation to 3 Billion. It's about the company Harvey, a platform that uses AI to streamline legal workflows, raising another large round, perhaps signaling the growing appetite for vertical specific AI solutions, even in industries that have been relative slow to hop on the AI bandwagon. As background, the platform leverages generative AI to help law firms draft documents, analyze contracts and manage compliance, all areas that are notoriously time consuming and expensive. The legal industry itself has traditionally been slow to adopt new technology. Even amidst, you know, the growing interest in generative AI. What do you think made the timing right for a company like Harvey to break through? At least with investors, Especially with other companies building simultaneously in a space, it.

Feels like AI is really coming. For some of these professional services businesses where historically, you know, selling to lawyers and accounting firms, it's been hard. Which isn't to say we don't have good companies in legal tech. You've got clio there, there are like meaningful scale. But it's all, I think it's been one of Those categories where VCs have been like selling those people is hard. They don't pay a lot, they're difficult to deal with. And I think AI has created this opportunity to go after professional services businesses by using technology to automate the work that that fairly expensive junior and mid level people do. And I think law makes sense. I think we've seen a pretty wide flavor of approaches. Some are like hey, AI is going to replace humans. Some are like AI is going to augment humans and everything in between. It's funny, there were two articles in the information this Week one about kind of PE style roll ups of kind of traditional services based businesses and then one today about just the meteoric revenue rise of some of these companies and whether it's sustainable. And I think think there's a lot of VC enthusiasm that AI might be the kind of crowbar that cracks some of these industries that have been very resistant to adopting technology. And I don't know whether that's changing buyer behavior. I think AI has put a level of urgency on a lot of people to figure out what does this mean for the future of our business. So I think there's more room for experimentation and by all accounts the Harvey team is very strong. So I don't know. I think in the end we're still many years away from knowing what long term lasting impact will AI have on most of these services businesses. I think in the beginning a lot of people said it's going to transform them and like they're going to become amazing. I'm like, we just don't know. And I think there's just a lot of momentum, venture capital dollars going into AI and I hope these things all work out. But I don't think we yet know what the long term impact of AI will be on law.

Also this week it's kind of funny, I know David Solomon said a nice quote that AI can now draft maybe 95% of an S1. And so that means that the remaining 5%, that's what actually matters. If the first 95 is basically a commodity, which I think there's, there's truth to that. But I don't know if AI gets that document wrong and there isn't enough power to double check, how quickly will people fall off the wagon. Again, it's almost two things happening at once. One is drumming up excitement about AI and legal and then the second is actually applying it to real world cases. And I'm wondering who are going to be the first folks to opt to do that. Who's going to be the first company to say, I'll raise my hand, I'll use AI to draft R S1 in the first run.

My hunch is there is a lot of boilerpate in a lot of business writing. My question is there's a lot of legal documents, documents we use that are fairly boilerplate and no, not to take anything away from the law firms we work with safes, they look the safe, they look the same. There's some find and replace. The value though is when you see something novel, being able to have eyes on it or when you See something that looks normal but is off and being able to catch that. I think AI can maybe help people with that. And is there a lot of value in having a, you know, first year associate or second year associate draft is safe for a startup? Probably not. But also people have to get part of training as reps. And this is one of my big questions. Historically in professional services, the way you got better and learned was you started with very mundane tasks and you repeated those kind of like making rice at a sushi restaurant. And so you got really good at like, hey, this person can do safes and convertible notes, red lines and everything. No errors. Now let's move them on to long form financing docs. And you went up this ladder of complexity by repeatedly doing basic things. And what happens when you skip the basic repetition? Sushi, rice making part of the journey. I'm just very curious what that means for people's professional development in these fields. And maybe we'll learn that those reps were empty calories and they were really useless and you didn't need them and it was like a form of either hazing or it was necessary for making the business of law or investment banking work. Or maybe we'll learn that like the attention to detail and a lot of the skills that you learn from doing those things over and over are a good reinforcement mechanism for what it means to be successful. Like my friends who worked at consulting would never have a typo in a deck. Like it's never like it literally like never happened. And I think it's because of the repetition and you know how it is having that like beaten into you over and over. I don't know what happens for people who skip that step in their professional journey, but I'm quite confident we're going to find find out.

Our final topic is a LinkedIn post by Jackie DiMonte from Grid Capital exploring how Q1 2025 will be one to watch as fund managers from the previous two years have been making proactive valuation resets and continued corrections to mitigate against the valuation highs of 2019 through 2022. I really liked her staging of what has occurred over the past three years. Basically calling out the reality that if you as a fund manager did not recalibrate in 2023 across your portfolio, in 2024 you had the year of reckoning and incurred some hard hitting markdowns across your portfolio. The hope is that this year is the year we see restabilization and growth across fund portfolios with full swing corrections hopefully being made proactively Marking down your positions across a fund is extremely painful for any fund manager, but especially if you were an emerging fund manager fundraising yourself. So I was curious to hear your perspective living through this past cycle and your approach to making corrections across the portfolio proactively, where it makes sense.

I think this is really hard because I just talked to a group group yesterday and they were like, how does valuations work? I'm like, well, every firm has a valuation policy. And they're like, well what does that mean? I'm like, well, every firm has a different view. Like for example, I know some firms that programmatically always hold things at the last round's valuation. And their argument is that is the most consistent policy we could apply with minimal discretion. And it means that sometimes we will be too low on a company because the company's outperformed, but sometimes we'll be too high because the company raised in a moment of enthusiasm. And I think for me The TLDR is LPs are very smart people. And whenever I ask them about this they're like, once we get to know a firm's personality, we know how to interpret their marks. And what's challenging as an emerging manager is your firm has no personality for LPs to know yet. And I have had situations where I've talked to LPs and remember LPs can be in multiple funds that hold the same position. So you might have something that you're holding at cost and your peers have all marked it down to zero. And I'm an LP in a handful of emerging manager funds where we've co invested with people. I'm holding the company at a very different price price than they are. And when I talk to them about it, the price they're holding at it is genuinely motivated by their belief in the company's prospects. So what I always tell people is you gotta have a valuation policy. And ours is simple. We don't mark up above last round valuation unless our auditors forces to. And I will liberally mark things down if I think they're underperforming. And I have other people who use Runway as a gate. And they go, any company with less than six months of Runway, we mark it down 50%. I'm like, well that seems kind of arbitrary but consistent if you apply it to all companies. And LP could look at your valuations and. But at the end of the day, Mia, this stuff is all like fog of war. Like I always tell our LPs what do you want with this TVPI number and truthfully there are some LPs whose financial compensation is tied to our interim performance. Not like the distributed DPI cashback. But our marks impact the IRR of the portfolio that they're in and that the performance of that portfolio might dictate their bonus for the year. So you have all these competing pressures. My view is I would rather just always be honest with our LPs and give them an accurate but conservative view of what our our portfolio is worth. The downside is there are other firms that I know that are far more aggressive than we are and I've had LPs tell us like, hey, I put your performance up against these other people's and theirs looks better. I'm like, well it's all unrealized and it's all speculative assessments of what private companies are worth. So yes, they might have a different point of view on the value of their portfolio than I have on mine right now. But in the end it will all show up as dpi. And here's why we're conservative and I think the lesson I learned in 23 and 24 is if you're conservative in a world where the people evaluating you think everybody else is optimistic, you get treated like the optimistic people. And whatever you do that's conservative will still get discounted because it's too hard to tell who's truly conservative and who's an optimist masquerading as a conservative person. And so I think you just have to decide like what can I live with? And I told her LPs I can live with you guys applying a discount to what I think are already deeply discounted numbers because we got well ahead of this starting in 21 and it's going to all work out in the end and it means it's going to be a little harder to fundraise and I'm going to have to work harder to explain and show you where the value lies in the portfolio. But I think anybody who hasn't done it yet, I don't know how you get through 25. Either those companies are going to fail, they're going to raise down rounds or it's going to be really hard to convince your auditors that a three or four year old mark on a company is still accurate.

Well, we are all out of time for this week. Thank you Charles for jumping into the learning corner. Thank you to our listeners for joining us. Please like and subscribe and we will talk with you all next week. Thank you. Bye.