Venture Is Paying 1972 Prices With 1972 Confidence. Here Is What That Costs You.

If the AI trade blows up and people lose a lot of money, I could name at least 5 or 6 firms that I'm sure will still be in business despite losing tons of money. And if that's the case, maybe the incentive is to just do the hot thing. Maybe that's actually unfortunately the system incentive, which makes me really uncomfortable to say it, but it is possible that there is not this corrective force that says if you underperform or if you make a blunder that you'll have to pay.

It's the week of March 9th. Welcome to The Learning Corner, a Precursor Ventures podcast. Welcome to the Learning Corner by Precursor Ventures. 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. For our first topic of the week, Micah Rosenblum, managing partner at Founder Collective Ventures, shared a piece on LinkedIn titled "The VC Returns Suck Narrative and How We All Spin the Data." The piece was sparked by two links that were dominating VC Slack last week. Dan Primack's newsletter declaring that VC returns kind of suck, and a viral dashboard analyzing 49 mega funds concluding that scale compresses returns. While Micah's first instinct was to celebrate what he always knew to be true, he pushed himself to be a little bit more intellectually honest, and what follows is 5 questions the partnership debated internally. He walks through everything from the structural flaw of comparing fully baked older vintages to half baked recent mega funds, to the unsustainable 1-to-1 ratio of VC firms to fundable startups at the 2021 peak. To the reality that many of the sacred tenets of venture, like ownership targets, pro rata rights, concentrated portfolios, are heuristics built off a handful of lucky '90s and 2010s vintages. He closes with a point that TVPI is heavily influenced by marks, and marks are in many cases managers grading their own homework. In this content of media floods, it is really simple to see a piece that fits your belief system and then use it as armor to double down into why your model wins. So I do really admire the self-awareness here. When you, Charles, see narratives like this catch fire on LinkedIn or X, how do you personally pressure test whether the data is telling the whole story or just the convenient one for yourself?

A lot of times people send me, see, this article says that portfolio constructions like yours work. I'm like, well, I already believe that, otherwise, yeah. I think this is kind of a theme for a lot of the articles this week. The GP perspective and the LP objective are not always the same. And, you know, LPs are building portfolios of their own too. They have their own set of objectives, which are largely, you know, if you're an LP and you're like, hey, I want to build a portfolio of 300 names, I want 10 managers, they each have 10% ownership in those 30 names, and I want no overlap. You could have two very good fund managers who love to collaborate together, and an LP could reasonably say, if I invest in one of you, I'll get most of the good stuff because hopefully the best stuff is the stuff you do together. I remember when I was at Uncorked, there was another fund we had 40% overlap with. We went to an LP and like, we already think we have exposure to the stuff that you have that's going to work because we think it's going to be predominantly the stuff. And it turned out that they were wrong. It actually was not the intersection of the stuff we did together. But I can understand the logic behind that. That makes sense to me. And so I always ask myself, what would make this uncomfortably difficult to process. When everyone's like, oh, like big fund size compresses returns, I'm like, but what if it doesn't? What if it doesn't? So every time someone provides me with something that feels intellectually soothing, I'm always like, but what if the converse is true? And so I think the big unanswered question— well, there's two. One, we have these massive, massive private companies and we don't know if the public markets will value them the same way. And to the TVPI point, if the manager's marks and the market's marks turn out to be the same, then grading your own homework isn't so bad. That's more like, yeah, grade your homework, you're putting your homework sheet into the Scantron machine or you're like pushing submit on the form. If it turns out that VCs are wildly overly optimistic about companies relative to public markets, then we do have a problem. We have a problem of marks. Also, there's just so little liquidity. Now, like you could say for the big companies, you'd be like, it doesn't matter what the public markets think. Stripe is basically a public company. If you wanted to trade out of it and lock in your DPI right now, you could. Plenty of firms have done that. But I think at the industry level, we've never had more private value creation without getting public market checks. So if it turns out that Databricks is as valuable as we think it is and OpenAI is as valuable as we think it is, then there will be mega funds that have small VC fund-like cash-on-cash multiples on much, much, much larger piles of cash. The VenCap thing from months ago, which is I think in a world where outcomes were all sub-a billion, highly concentrated funds with high ownership were the only way to make the math work because the ceiling on exits for private companies was small. We have now lifted the ceiling by at least 100x. Maybe we lifted it by 1,000x. And so why would you believe the strategies that work at a billion-dollar terminal outcome are the only strategies that work at $100 billion or trillion-dollar outcome scale? The issue is we just don't have enough data or experience to say, but I think LPs are smart people and I think they will realize if the terminal outcomes can really be as large as we think, and we think that this manager can get into those companies, I think the next 10 years of venture, I think LPs are going to go back to, you know, they used to always say venture capital, it's not an asset class, it's an access class. And like you either are in the right fund managers. I think we're going to go back to a world where LPs are going to say, I don't care what your strategy is. If you have access to the consensus hot companies that we think will become $100 billion, I don't care if you own 1%, 0.1%, 10%. All that really matters is can you get into those companies, whether by hook or by crook, in large scale or big scale at precede, I think we might end up in a world where like all of this stuff gets scrambled.

But would that be counter to then the hang up here with LPs that like I need you to get to 1x DPI as quickly as possible because if you had. But I guess to your point, if the outcomes are so outrageously large, if you had even just 0.1% in that company, maybe it could bring you to 1x or at least 05.

I think like the more dystopian thing that could happen is if you're not in these 10 companies, I'm not taking the meeting. You have all these really interesting companies. Good for you. You're not in the hot names that I care about, and your hottest name isn't that hot. You're not one of the chosen few who has access to these. But this is all predicated on the fact, the belief rather, that the companies that we think are hot today are going to be the companies that matter in the end. We could go back 2 years and say like, what companies were we really excited about in the world of AI? I think the list would look very different than it looks today, and it'll probably look different again in 2 years.

One quote that I liked here is that Micah opened the piece saying that Ventures starting to feel a little bit less like finance and more like politics. Just everyone kind of like advocating and pushing the place that their capital strategy sits in. I guess for you, at what point do you know when you're having a conversation with somebody where you know your strategies are completely different? You're like, oh, we're not gonna meet in the middle. Is it worth me chatting through why I sit where I sit? How do you even pick which, not fights, but like which conversations to double down in?

I have a general rule, which is I'll talk to anybody who I think is trying to get to a yes. If they're really trying to get to a yes, there's a conversation to be had. Sometimes you meet LPs and they're just like, I don't believe in your portfolio construction. Well, I don't know where we go from here. I've not found that like trying to educate people about why it works works. So usually if I meet someone like that, I'm like, I'm curious as to why you don't believe in it. I'm obviously not going to change what I do. You're probably not going to change your belief. And that's most of the interesting learning I've gotten has been from people. For example, that one LP was like, I'm trying to build a portfolio of 300 names where every manager has consistent ownership and where I have consistent ownership in that fund as a percentage of the fund so that like I have kind of consistent exposure to those names. And my belief is that those 10 managers will get into the companies that matter. And because they're not overlapping, I'm increasing my— I'm like, oh, you're doing what I'm doing, but just through the lens of a portfolio. And he's like, look, a fund that gives me 100 companies in a single shot with less ownership than I want does not help me achieve my portfolio objective that I'm trying to create. He's like, but I actually understand why you're doing what you're doing, because you're doing the same thing I'm doing, but for yourself. And we, in the end, we're kind of like, we can't work together, but we understand each other.

Do you have the same thought process for peer GPs who just sit in different categories when you're kind of like sparring over strategies, or it's just different?

I imagine I have people who I really respect who make like 2 and 4 investments a year, and I tell them, I don't think I could do what you do. My brain doesn't work that way. And they tell me, I don't think I could do what you do. It seems like terrifying. I'm like, well, what I do feels natural to me. And the weirdest compliment I ever got, I think it's a compliment, was from an LP who passed on our funds and I showed them returns and he goes, well, this, I still think this is a bad idea, but it seems to be working for you.

Thank you.

Thank you. I think you want the follow-up or, but I know what that person was trying to say, which is like, I refuse to change my mind about the thesis in theory, but I'm willing to acknowledge that it might be working for you.

Well, our next piece is from Jeff Weinstein, partner at FJ Labs on LinkedIn, where he opens with a history lesson that reframes how you look at what is happening in venture right now. He goes back to the '60s and early '70s when Wall Street became obsessed with a group of 50 blue-chip growth stocks, companies like Xerox, Polaroid, Disney, and Coca-Cola that were seen as so obviously transformational that valuation almost didn't factor into the conversation. Investors piled in with total conviction. And for a while it worked until it didn't. By the mid-'70s, many of those stocks had lost more than half their value. And anyone who bought at the peak consensus in 1972 spent the next 26 years underperforming the broader market. The companies were great. That wasn't disputed. The prices were the problem there. And Jeff's point is that venture is at a serious risk of repeating the same mistake now, where the power law logic of backing only the biggest perceived AI winners has shifted from being a genuine investment insight into something closer to a crowded consensus trade, the concentration of capital into a small handful of mega rounds has only accelerated, and the size of these raises has started to make 2021 look restrained. He did also write a follow-up piece that gets into where he thinks the real opportunity actually sits as a result, and namely places that have largely been abandoned in the rush towards consensus. Jeff's whole argument is that everyone being right about the same companies at the same time is exactly what makes it dangerous. And if you zoom out, Charles, across cycles that you've seen up close in the past, is there a pattern to when the consensus trade actually breaks and what tends to be trigger. I know we've talked about the opportunity arbitrage window before, but anything that you've gleaned from the past?

I just think life is easier if you go with the flow and you're like, everybody else is doing this. I think easy and making money are oftentimes at odds. And so I read this and I was like, if you look at the firms that are in Quince, one of the companies you mentioned, quite surprising. They are not the firms you would expect to be in that investment. And whenever I tell folks, how well our CPG portfolio is doing, they're usually just like, first of all, why are you even in those companies? And second, why haven't I heard how well they're doing? I'm like, because nobody cares right now. And so I've always felt like one of the best things about being a generalist is you can like shop in different aisles. You can build a portfolio in different categories. The upside is when things go out of favor, you might have the in-favor thing. The downside is when everybody's consensus in on one category and you're a generalist, it can feel hard because you're working with founders and you're working in sectors that people just literally don't care about. And it can be hard to like show up to a party and tell people about the last investment you made. And they're like, it's not an AI harness company or it's not a fund. Like, you're like, no, it's not. And they're just like, do you understand your job? And so I do think it's a good reminder that oftentimes the companies that matter in the end are not the companies we think matter in the moment. And I won't pick on specific companies, but I can think of even 3 or 4 years ago, there were brand new AI companies that people just assured me were going to be consequential and they just haven't been.

It also made me think a little bit more macro, but about the generation of investors coming up right now who are a little bit more junior, who've really only known one playbook, which is right now to just find an AI angle, back consensus winners, compete for similar logos or things that look like them. And I think it's just because that's ultimately what their partnership is telling them to do. They haven't lived through a cycle where the consensus trade completely unwound and the people who looked contrarian ended up right. Yet. What are, I guess, from your perspective, the real downstream consequences of raising a generation of investors inside that kind of monoculture?

I think it depends on— and this is something I've been thinking about a lot for like the last 2 years. You know, in a, in a theoretical world, if you— if this were public equities and you were bad for 2 years, you would just get fired. Your LPs would redeem and like would move on and you'd be out of business if you're a hedge fund. I think in venture, it's actually not clear to me that there's much in the way of a corrective function. And I don't say this to like blame any actor in the ecosystem, we kind of blew everything. I don't know. I watched Margin Call on the way back from a birthday party with a bunch of finance people. And there's like this part at the end where Jeremy Irons is having dinner by himself and he's just like, we just do this all the time. And he like goes through a litany of like finance-generated bubbles that kind of blew up the economy. In the end, he's just like, well, we're going to do it again. As always happens, we blew it up and we're going to make a ton of money on the way back up. He says it like very matter-of-factly. And I think in venture, there aren't that many people who've had to pay a steep price for the excesses of 2021. We've kind of like memory holed that whole era. And I'm actually not entirely sure that if the AI trade blows up and people lose a lot of money, I, I could name at least 5 or 6 firms that I'm sure will still be in business despite losing tons of money. And if that's the case, maybe the incentive is to just do the hot thing. Maybe that's actually unfortunately the system incentive, which makes me really uncomfortable to say it, but it is possible that there is not this corrective force that says like, if you underperform or if you make a blunder that you'll have to pay.

I mean, I've heard LPs literally say, I just write off any vintage from 2021 in my portfolio. Yeah. So in fact, no one gets, no one gets dinged for that. I just have written it off.

Which I think changes the incentive system for you as a fund manager. The incentive system is a long, long time ago, someone I've known since the early internet days was like, look, if you went all in on bubble '96 to '99 internet and you rode that thing and got out, it doesn't really matter what else you did since then. You would have done so well. And same thing was true of optical networking, probably early fintech. For some of these themes, if you catch them early and you get them right, venture is a weird business where you can be right one or two times in your career and be fabulously wealthy for the rest of your life.

I think for more junior folks who are coming up in this time, I actually think like this is the potential to be, I don't know, probably one of the biggest learning moments.

Totally.

And you ask questions to yourself of, do I want to be in venture? If either one happens, if it's a massive success and everything is valued at the way that we've marked them, then you're sort of like, wow, I've I've participated in one of the most lucrative times within venture. And then if it doesn't do well and you were an analyst at like a large fund or a mid-sized fund who was participating in that, you will be able to take that learning to the next thing and decide, do I wanna participate in this and take these learnings with me, or am I out completely and I'd rather be on the operating side or be completely outside of the asset class? I think there's a lot to be gained. Our last piece is from Rob Goh at NextView titled The Four Approaches to Early-Stage Venture, and it's a clean framework for making sense of how different seed investors actually make decisions, even when they all claim to be doing the same thing. Rob breaks early stage investing into 4 distinct models. He's got classic institutional seed, specialist seed funds, multi-stage mega funds that stretch down to seed, and then accelerators. And he's super candid about the real strengths and failure modes of each. What makes this piece interesting is that he does not declare a winner. His view is that the pie is big enough for all 4 to coexist and that the failure mode is not picking the wrong model, but not knowing what game you're actually playing.

Yeah.

He closes with the line, don't let LPs be the tail that wags the dog. What's right for an LP in the context of their portfolio is rarely rarely exactly right for the manager. Rob is pretty direct that the failure mode is constantly chasing your own tail and not knowing what game you are actually trying to play. How much more common is that type of failure now versus years ago when the venture industry was more of a cottage industry?

I think it goes back to the thing we talked about at the beginning. I think the reason there's so much narrative competition in venture is because people feel the need to justify what they're doing in an environment that's become far more complicated. And my experience has been The big challenge with narrative competition is that everybody doesn't have the same size megaphone. The multi-stage funds have a disproportionate impact on the point of view of LPs. In my experience, because LPs have more money with them, they have more access to the senior decision makers. And I think the smart ones use that access to shape LP perspective on how the world works. And so I think if you're a seed fund manager and you haven't been asked how does the How does the incursion of multi-stage funds into seed impact your business? I simply don't believe you. Everybody's being asked that question. And the answer you give is a function of like your strategy and your belief system. But I think that question's being put to seed managers because multi-stage funds have said, we're going to play in seed too. Those folks have lots of access and they, they can tell a piece of story. All of these brand assets and reputation we have are transferable from Series A to seed. And to some extent it's true. You know, I don't know many people who wouldn't take money if a senior partner at a big multi-stage firm called them up and said, hey, I want to invest in your company. That's actually not what's happening in most cases. And I would flip it around. The question is, I've found it's very difficult to discredit somebody else's strategy, and it's probably not worth your time. It's probably more important to focus on why what you're doing works for you specifically as a manager and how your strategy can still outperform. And look, I think right now we're in this like consensus squared environment., and so the less consensus to your idea, the harder you have to work to compete in this narrative environment. And so I find that the next best thing to being a multistage venture fund is being a seed fund that invests in the same deals as all the multistage funds, because you can tell somebody like, we're investing alongside these folks. But the tricky thing is seed fulfills different objectives for different firms. For a dedicated seed manager, seed is where you make your money. For a multistage firm, seed is where you do a lot of things. It's where you stay current. It's where you build new relationships. It's where you get intel on what's happening on the ground floor. You also can make some money, but making money is one of maybe 3 to 4 objectives you have. And I think that to me is the biggest difference now is that before everybody who was in seed, it was their primary business. It was the way that they made money and everybody kind of had similar objectives. When you inject in a bunch of new players who have a variety of objectives where making money is one of them, it does change things in a pretty material way.

My last question here, is a little bit more existential about how much time we're spending with an AI, but Rob flags that the best generalists often outperform specialists over multiple vintages. And I have a feeling we obviously agree with that one here. Yeah. But if the majority of capital and fund activity right now is concentrated in AI and nearly every deal has some AI angle to it, does it make the so-called generalists of this cycle accidental specialists? Where do you fall on that? If like every single deal that I've done across healthcare against construction against— it all has an AI piece?

I think it's like mobile. There was a period of time when like mobile happened. Mobile was a differentiator. We're like this thing but mobile, or we're the mobile-enabled version of X. And then it just became, well, of course you have a mobile version because you're, you have a brain. And I think AI went from a specialty domain where you had firms, Basis Set and Zetta, you had firms who were like, we're specialists in AI. And I've always felt like this is the, the risk of being a specialist is that the thing that you do becomes so big. We've talked about this with SaaS before with emergence and other firms like it becomes so big that everybody does it, and then it ceases to be a specialty practice anymore. And I think AI has clearly crossed over into that. And I think now to be a generalist, you have to actually work much harder to find stuff that doesn't fit those consensus narratives.

Well, we are all out of time today. Thank you, Charles, for hopping in. Thank you to our subscribers for jumping in as well. Please like and subscribe, and we will talk to you all next week. Thank you.

Bye.