Venture’s Last Small Funds Just Went Big. What Changed?

The biggest risk in venture is that bending spoons is closer to being right about these values. We could be wrong by an order of magnitude. And if we're off by an order of magnitude, a lot of money will be lit on fire. And if we're off by like a multiple, you know, if some of these companies that we think are worth $50 billion are in fact worth $15 billion, it's probably actually okay. But if they're worth $2 billion or $5 billion, we've got real problems. And I don't know when we're going to find out the public valuations, because most of these companies seem uninterested in going public.

It's the week of October 12th. 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 comes from Kyle Harrison on his Investing 101 newsletter titled The Death of Venture Capital's Short Kings. The 2 firms that built their entire identity around staying small on purpose have both scaled up within the same year. We had Benchmark raise $2 billion in June, including its first ever growth fund, and Union Square Ventures just announced $900 million, the largest fund vehicle in its history after Fred Wilson said back in 2010 that USC would never raise a large fund. Kyle's read is that this was less a change of religion and more a response to the value chain of capital where the decisive rounds now happen downstream and are owned by giants. So the only way to protect your founders is to be big enough to sit at that table. He also pushes on whether more capital actually creates more companies, citing Roloff's point that there are still only about $20 billion exits a year, despite venture dollars growing roughly 5 times over the decade. Charles, wanted your more general reactions to some of the folks who did pave the way for similar-sized fund vehicles now moving into a new era in their strategies.

Yeah, I think about the James Bond movie, Never Say Never Again. And I think in venture, it's very difficult to say like, you'll never do something. The world changes. You know, we talked about this in our team meeting. I do think it's interesting that both of these strategy changes were made as part of a generational leadership transition. I wonder if that has created space to reevaluate some of the core tenets. It's very hard as someone who runs a fund, I can say it's very hard to abandon principles or beliefs that you held when you started, even if the information around you changes. I think the central question in venture right now is, is it really different this time? And I think in the for camp, there's 2 things I think about. One is AI does feel like the biggest tech shift I've seen since the internet itself in terms of magnitude. And second, in my entire career in venture, I've never seen a protracted decline in assets made available to the industry. If invested dollars go up on average every year, it doesn't mean there aren't years like 2008 where you have pullbacks, or 2022. If it's generally up and to the right, then it's unlikely that venture is going to voluntarily become a smaller asset class. And if AI is a big megatrend, you could say, okay, well, that would suggest that maybe even just adjusting, as Benchmark said, adjusting for inflation, fund sizes should get larger because a dollar today punches differently than a dollar than it used to. And, you know, with Cursor and SpaceX, The scale of the outcomes is different. That's like the bull case. The skeptical case is we're in a bubble, and in a bubble it always feels like this time it's different, and people abandon all of their rules. There's always a group of people who hold out for a long time and capitulate right at the top. Because at the top it feels like those are what I call expensive beliefs. And holding on to like fund size and round size and discipline when everyone else has abandoned it, when you're the last person on discipline island, it's really hard. And so I think for both of these firms though, if I were in their shoes, I would have done the same thing. Because if you're benchmarked and it really isn't different and you realize $2 billion is too much, you can just raise less next time. No one's going to fault you. And given their historical track record, my hunch is they'll get a mulligan if for some reason the $2 billion is too much and they can't return it. They won't get an infinite mulligan, but I think they've earned the right to revisit. And same thing for USV. And if it is different, you've got to learn how to manage a fund of that size. And I think we've— the venture world, in my opinion, is going through another bifurcation, which is that firms for whom it's important to be lead firm and write the check they need to kind of drive the agenda on the round and people who are happy being a part of the party. And so I think if you're going to be a lead firm, you have to have a fund that's big enough to speak for the amount of capital that founders want in the universe of founders you want to compete for. And if you're a firm that doesn't want to lead, I think you just have a lot more flexibility in terms of like check size and entry point. Yeah. I think it's pretty clear that Benchmark and USV, I think culturally are firms that are accustomed to being the firm of record. that leads around. That's their personality. That's their reason for being. They believe that they're good at that work. And so for them to just say, we're no longer going to lead, we're just going to tack on a check. That's not the ethos of why those firms were created, or even I think how they view themselves and their role in the ecosystem. And so I think we are seeing this sorting in venture where there are firms who are like, hey, look, even at seed, you're like, hey, I might need to write a $5 to $10 million seed check to like lead around for a, for a small seed round. I might need a check of that size. That might mean you need a $300 to $500 million seed fund to do 30 to 40 companies per fund at that size to have, and have some modest reserves for the next round versus a firm who's like, I just want to get in. I'm not going to take a board seat. We're not ownership oriented. We're access oriented. Firms like that can exist at anywhere from $25 to $100 million in size. And I think that is like the new bifurcation that's happening in venture. We already had the bifurcation of like big firms and small firms. And now I think we're having the second bifurcation of firms that want to lead and firms that are like happy to participate.

Well, certainly if you participate at the A, makes logical sense to size up because, I mean, we'll talk about it in 2 pieces down for Navdeep from Lightspeed writes about this because that graduation rate has dropped so much from seed to Series A, you have to be in the Series As that matters. And so much of that has to come down to how large of a check can you write, which is different than the game prior. Do you feel like your perspective on leading at the earliest stages has evolved? There was a time when, again, like a $500K check was a lead check in a pre-seed round or whatever we're calling it now.

I think Generally, like there's 2 jobs of, well, there are many jobs. 2 of the big jobs of a lead investor are to set terms and price and to catalyze other people coming into a round by your participation. A good lead does both of those things. And I think there was a period of time when pre-seed rounds were small, where a $500K check from a highly regarded pre-seed firm could actually catalyze a round. But like in a $10 million pre-seed round, a $5 million check does, it does nothing. It does not probably dramatically increase the probability that that company will successfully raise. And so I think in that world, you're like, oh, well, a fund that can write checks of that size can certainly get into many, many great rounds, but probably won't lead them. And so I think about that a lot as it pertains to our firm. And, you know, one thing I was talking to Marina about this week is there is a world in which you could say, well, what if we're really going into another bifurcation, which is there are firms that invest at valuations below a billion and firms that invest at valuations above a billion. And you're like, wow, that's a crazy range. 10 posts to a billion. You're like, but. In the grand scheme of things, those are all various different ways to get to 100x returns. And the argument might be that like, look, there's early stage investing, which is pre-billion. And then there's like later stage has nothing to do with traction or risk profile and everything to do with entry point and capital deployment. And I think it would be wild to have a website that says we invest at sub-$1 billion valuations. And you'd be like, well, how do you make sense of those? You're just like, The market doesn't make any sense right now.

Kyle closes the piece by saying that as capital concentrates at the top, the long tail of companies that mega funds can't see gets bigger and more underserved. So the folks who may be sitting at like 9-figure exit value or just like hover around the sub multiple billion in valuation, and he says somebody is going to eventually figure out how to serve it. I read that piece and said, well, isn't that traditional venture? General, like, isn't that how it's always worked? Just the long tail in venture and those size exits. And there are plenty of firms already built to serve those outcomes. And we've talked about this, most of them are struggling to raise right now. So how are we as an ecosystem wrestling with that dynamic? Does it matter that there's data out there that there are only $20 billion exits a year that exist in the market? How do you make sense of it all?

I have like so many thoughts. When I got to the end of that post, I was like, part of the problem is Whoever's going to solve that problem probably shouldn't call their firm a venture capital firm because I think nobody wants to be playing small ball in venture. And I think if you're like, oh, I'm a venture capital fund, but I'm like shooting for little exits, everyone's like, so you're a loser. I hate to say it. I think most people are like, oh, so you can't win at the main thing. So you're like in the minor leagues. And it might be a very lucrative financial decision. I think from an ego and reputation thing, I think most VCs would be like, well, I don't want to be in the backwater minor leagues. I didn't sign up for this job for that. But if you had a different firm or different firm construct that was called something else, you could become really good at, like, you know, I think about like lower middle market

private equity. I was just about to say that.

They don't call themselves, they don't call themselves like baby private equity or, or little, they're just like, oh, we're gonna carve out a new sector and we're gonna like give it a name. Boutique. Yeah. And so I think somebody will figure out, also, I think if you're a founder, you're like, well, also I don't want the loser B-team capital either. So someone's gonna have to like brand and describe this type of capital. in a new and interesting way that attracts good founders. But it's work that needs to be done. But I think what we haven't solved for yet is it's unclear to me that all of this kingmaking is going to actually produce kings in the end. We have a lot of very, very highly valued companies where essentially the same 5 or 6 people are investing in the same companies. And they're just like, well, this is the one we all want to win. And we think it's going to be worth a lot of money. And I'm like, none of these companies are being exposed to the scrutiny of people who are less enthusiastic about tech or have the ability to put their money into other categories. And again, I think I told one of our largest LPs over the weekend, the biggest risk in venture is that bending spoons is closer to being right about these values. We could be wrong by an order of magnitude. And if we're off by like an order of magnitude, a lot of money will be lit on fire. And if we're off by like a multiple, it's probably like, you know, if some of these companies that we think are worth $50 billion are in fact worth $15 billion, it's probably actually okay. But if they're worth like 2 or 5, we've got real problems. And I don't know when we're gonna find out the public valuations, 'cause most of these companies seem uninterested in going public.

It feels like we're just in one holding pattern until something happens in the right direction, in the wrong direction. Nobody feels like they need to shake it up.

But I, I do think we could end up in this very fascinating world where there are actually— talk about Back to the Future— there are 2 ways to make money in venture. One is to keep your funds small. Mm-hmm. And participate in this medium-sized $500 mil, we'll say $500 million to $5 billion exit world. And as a GP or someone who's a, who's a carrier participant at a fund, you might end up making a lot of money for yourself personally. You will have earned it through being a good investor. The other one is you just keep raising gigantic funds. You make a boatload of cash on fees and maybe there's never a— like, I don't know when we will ever be done with the 2021 batch of companies. Mm-hmm. It's 2026 when we're recording this. Most of the, a lot of those companies are still alive. They still have cash. People are carrying them on their books as TVPI. Nobody knows what they're actually worth. And we might not know till the end of the decade. When 2021 happened, I was like, well, we're not going to find out tomorrow. But I was like, by 2025, I would have thought we would have known more, which means whatever's happening now, my hunch is we won't know until the end of the decade. Character AI filed for bankruptcy, but I was like, but wasn't Character— I mean, no offense to anybody who works there— wasn't that over a long time ago? Yeah. After the Aqua License deal, it wasn't that kind of, but it still took a few years. And I'm sure the people who worked there were working on it. It still took a few years to get to resolution on that.

And part of that has to do with, we have an entire infrastructure of funds that are set up to make sure that those companies like don't go to zero right away. They have like a long ramp. And I think that makes sense for them. To your point of like the bifurcation of 2 different structures of what quote unquote venture or whatever we're going to call it looks like, the bigger funds I think have figured out quite quickly what ways to start getting more creative around how to make sense of the fees, how to continue to make money in other ways. We've seen GC do it, acquisitions of hospitals. Yeah. All the different types of business models that they can set up in relationships with startups thrive. Same thing, which I think makes tons of sense. Once you become an RIA, like you have to start thinking about more creative ways. You're making me think like, okay, now there's an opening for the smaller mid-sized funds have to figure out where they want to become creative. Because maybe you're right, the old traditional version of what true-on-true venture capital looks Like might be evolving in the same way that private equity did.

And I think if you think about what would you care about if you were going to build one of those firms, it's actually a different environment. I would argue in a theoretical world where I were gonna design one of those firms, I would say, well, the first thing I'm gonna get rid of is any assumption that the primary way we're gonna make money from these companies is through IPO or M&A. Let's just get rid of that. And maybe you take some of the tools of private equity. I mean, it's hard to do dividend recaps and some of these other things if the companies don't produce underlying cash flow. But when you just say like, hey, I'm not building all of these companies to sell. Some of them I'm going to build and they're gonna become profitable. And like, we are going to— the, the returns profile looks different, but the toolkit you can use is really different. Yeah. Which is why I think whoever decides to tackle this should really spend a year figuring out what am I gonna call this new asset class and how am I gonna differentiate it from what venture capital is? Not in a way that like throws venture capital under the bus, but in a way that like I can carve out a new lane. You know, I listen, One of the best events I went to last year was the Stanford GSB Investing Summit. The fascinating thing was just hearing people from the early days of private equity be like, no one like knew what it was. We had to sort of define it and describe it. And I think in some ways this is gonna create the opportunity for somebody. But I think if you think like, oh, I'm gonna redefine venture, you're gonna get stuck in the loop of like— Yeah. All of the strictures that we grew up with. And I think you have to say like, I'm gonna define a new style of investing that's designed for the companies That are not gonna be $10 trillion in size. Yeah. And like, I'm gonna create an investment model and investment vehicle that speaks to those companies, but also invest in high-quality assets.

And it's all cyclical. I think of the rush into search funds as well as like, yeah, actually I personally could make 10 times more money than working at a Blackstone or BlackRock if I just found a smaller business that I can own outright, take smaller amounts of capital. I don't need $600 million. I need 20. No, I need 5.

Yeah.

And I'll buy up a couple of like garden nurseries and I'll run them. And I personally will have more life-changing wealth than some of the MDs who sit there. So, and now people, I would say like the search fund model has like moved outta favor. Like people have to figure out where do they wanna sit within that space. So it never stays as stagnant as you think.

I think in most things in finance, a lot of the returns go to the people who get in early. And I think a lot of people had feelings about, I think it was Doug Leone's thing about the, the Novocaine, like the, I didn't want the Novocaine thing. But the other thing he said, it was like a monkey could have made money in venture capital. I don't think that's true, but I do think what he was describing and getting at is there was a time where this industry was not well understood and it was very inefficient. Yeah. Because founders didn't have access to much information and there wasn't much capital. So if you were a startup founder who wanted to raise money, You had relatively few choices of whose money you would take. And those firms were generally more like a cabal. They were going to give you roughly the same pricing and they made a lot of money because it was an inefficient— and now I'd say venture capital is like a pretty efficient, well-understood market. And so the question is, if you were to start today, where can you find these inefficiencies? And I think one area is this notion of the companies that are like, quote unquote, too small for venture, but not profitable enough for PE. And is there a firm model? in there for these early stage growth companies that someone will pioneer and build a whole new either sub-asset class in venture, just like seed was a sub-asset class in venture because most people thought it was bad work. So it takes like, I think a creative mind and a new model, but I think somebody will crack the code cuz I think there are entrepreneurs who need that capital, who need and want that capital.

Our next and last piece, since they're so meaty this week, comes from Namdi Regulum titled Valuations Need a Correction. It's a follow-up to his earlier essay on taking stock of the seed stage. His argument is that the private valuations we all quote are not really valuations at all. They're financing prices observed only for the narrow slice of companies that successfully raise and only at the moment they raise. Once you correct for that selection bias and estimate the value of every active seed company, not just the ones transacting, you get a chart that he calls, and he constructed, quote, up, down, and to the right, that tells the real story. From 2010 to 2017, the aggregate value of the seed market and the number of active seed grew in lockstep, essentially one line.

Yep.

And then they split. The value exploded in 2021. It was corrected and has partially recovered while the seed population peaked in 2022 and has shrunk every quarter since.

Yep.

Which means the entire recovery is valuation driven.

Yep.

His read is that it feels unhealthy for prices to be up.

Yeah.

While quantities are down with value concentrating in a smaller and smaller group of companies. And he points to the same story playing out in the S&P 500, where Apollo last year published a report and flagged that index gains are concentrated in the Mag 7 and AI names. His warning is simple. When only winners transact, prices can keep rising even as the market underneath them deteriorates. Nambi says the eye-popping seed numbers are essentially irrelevant to what the median seed company is worth. My question is. Does that matter in the game of venture that we're all playing right now?

It does. And I think a lot about that old saying, the market can remain irrational longer than you can remain liquid. And I think we're in one of these moments, 'cause a lot of people are like, well, this doesn't make any sense. And I'm like, well, if you need to fundraise or participate in this market, all that matters is the current conditions. If you could be like, oh, this is a bubble. And when it pops, I'm like, but what if you're not around? What if your firm's not liquid? What if you're not like, so part of this is you have to be around on the other side. I think what Namdi described is what it feels like, which is like more money for fewer companies in seed. And it is this weird bimodal distribution. Like you can raise a lot of money or no money. And that's kind of the world. I think the other thing I think about a lot from this article is I talked to LPs and they're like, well, who does these little seed rounds? Everything I read about are these $50 million. I go, well, you read about them because they're rare, but it's this weird information feedback loop. These eye-popping seed rounds happen and they get written about because they're rare and because they're surprising, which resets the casual reader or even the informed reader's perspective on like, well, what does good look like? I had a founder, Mia, this weekend who emailed me and was like, well, I'm gonna raise an $8 million Series A. I was like, I don't know anybody who does those anymore. And she was like, what do you mean? I go, no, that's like not a thing anymore. That's a seed round. And the founder was like, well, I already raised a seed round. I go, I'm simply telling you that if you go to market with an $8 million seed round, that might absolutely be the right amount of capital for your company. And I don't know that many people want to participate in a seed round that small in the venture ecosystem. If there was some alternative capital provider or somewhere else, maybe. And I think this has real consequences for founders. I think we now live in a world where people infer company quality from ability and size of fundraise. If you're a good company, you're supposed to raise a lot of money at a high price. You're like, well, what if you can't use it? What if you can't manage it? And I think this has been happening for 5 years, but it's really accelerated. There were all these things written about the joy of capital efficiency and how all of these like low costs were going to make, could create this amazing universe where companies could be created for less money and could sell for less money and everybody would make more money. And I think what ended up happening is that funds were like, well, I'm going to go raise a lot more money. So I don't care about capital efficiency. And in some ways it's antithetical to my objective, which is to deploy capital. And so I think we're finding ourselves in this world where if you're a founder who needs less capital, there are actually fewer traditional venture capitalists who are interested in hearing that story, cuz most people's job is to move money in large blocks.

I just had that conversation with a founder yesterday. I was like, I think it's gonna be easier for you to go out and raise $3 to $5 million than it is to be raising a sub-million. I think you're gonna have to just aggregate a bunch of angels. You won't get a single institutional VC. If you do, like, it'll be a small check maybe, but you might as well just go out and raise $3 to $5 million. It'll take a shorter amount of time if your market is big enough. We are in the bubble, we are in venture, like that's how our careers are made. Yeah. So we understand that just because something is priced a specific way does not really mean All too much. I think there used to be a time where it did. I love the quote that he said. He compared it both to housing prices. Like, imagine if only the most expensive houses on the block got sold. That's right. Is that how you would think the whole housing market is priced, or is it just the small few? And then he also had a good one on like voting. Quote, rather than the always-on debate we see in public markets, for private, it's like an electoral debate. It's infrequent and it's unrepresentative, a media spectacle rather than an informative exchange.

Yeah.

And like elections, the voting only happens once in a while. I feel like if we're gonna have more and more of these mega rounds, these trillion-dollar valuations at earlier and earlier stages, do you think people at one point will call for more of an audit process on what's going on to drive and, and, and make sense of the valuations or no? Yeah. Like, well, it doesn't work for the ecosystem that we live in.

I think there's that. I mean, how many, how many clichés can I throw in here? The weighing machine versus voting machine. Analogy. I think to some extent there was this really strong argument that the private markets and public markets are in fact different animals. And I think that was easier to make that argument when you're like, A, companies of consequence eventually go public. And B, like the companies that are private are kind of small and inconsequential. Those 2 things went together. And now you're sort of like, well, for some of these companies, like for some of them, I know that they're being audited. They're, they're already going through audits. They're just not public because these are companies that plan to go public. So they're doing the training wheels thing. But I wonder if You know, there is a world where like this distinction over time between the public and private markets goes away and people are just like, look, they're just companies. They're small companies and big companies. And instead of having public company accounting and private company accounting, we're going to have big company accounting, which is going to be like, hey, if you're making more than X dollars, you got to report and do all these things, especially as there's more retail investor access to private markets. I think it's going to be, and look, I think eventually in order to fulfill the ambitions of the owners of these gigantic asset management firms that practice venture capital, they're going to need to hit retail just like private equity did. And so, and look, some of those, I think some of those fund managers' aspiration is to take those platforms public. Ironically, none of their underlying portfolios want to go public, but maybe the funds that invested in them have more of an incentive or interest in doing so. I think we'll, I think we'll see, but I don't know, Mia. I think it's interesting to me that there's really no money coming out of the system and everyone's like, well, Anthropic, And OpenAI, I'm like, well, they have to actually go public. It was supposed to happen this year for both of them. Now maybe one of them, but maybe not. You know, the year is— we're getting close to the end of the year. I don't know how much longer our industry and our business can continue to deploy capital and point to TVPI and not send bigger chunks of money home. There's a set of firms that I think have been given longer leashes than others, but those leashes aren't infinite. Hospitals have to be built. Dorms have to be built. Pension obligations have to be met.

Like, it's not all fairy dust. I will say and close with this that it feels like the old version of venture, there was math. There was math attached to like, what are the multiples to kind of get to a valuation? It existed across every industry and there was like a time of which there were shining benchmarks of which to uphold it. I think people forget that this is an emerging industry and the underwriting principles of it are still to be determined. And so, so much of the valuations are just based off of like purely spectacle of, of, I think if this all makes sense, this could replace every single white-collar job. So that's how I'm underwriting it. But then it leaves out all of the different assumptions that you have to do, because we've never seen it come in full circle yet. Like we're still in the early innings.

And also like people are just like, oh, the best companies always felt expensive and were misunderstood. I'm like, that was true of Facebook. That was true of a lot. But so, so were bubble era companies.

Yeah.

So like it's true in both directions. It's like, yes, the best companies often turn out to be far more valuable. than we think. And the ability for the market to sustain bubble valuations is oftentimes stronger and longer than we think. And both of those things can be true.

Well, we are all outta time. Thank you, Charles, for jumping in. Thank you to our listeners and subscribers for joining as well. Please like, share with friends, and we'll talk with you all next week. Thank you. Bye.

Bye.