Why Founders Need a VC Prenup — and What AI Still Hasn’t Figured Out

I've talked to founders who feel this same frustration, which is, hey, I signed up for the Venture Capital rocketship. Now that I know more about my business, it isn't one of those how do I get off?

It's the week of May 5th. Welcome to the Learning Corner, a Precursor Ventures podcast.

Welcome to the Learning Corner by Precursor. I'm Mia Farnam and I am joined by our GP and Managing Partner Charles Hudson, where we will be talking through the articles and Goodread that caught our teens attention over the past week. This week we're also lucky enough to have one of our awesome graduate school interns, Leon, join us in our virtual studio. Welcome Leon.

I always learn so much from our discussions. Thank you for letting me join this week. Excited?

Cool.

So our first topic is a blog post from Edited Capital titled We need a VC Prenup Creating Off Ramps for Tech Businesses. It addresses a growing tension adventure. What happens when a startup no longer fits the traditional scale or die model but still has a viable business? The post proposes that instead of forcing a binary outcome, either raise more capital or shut down, we should develop better off ramps for founders. Written from the POV of a PE firm, this obviously could include private equity acquisitions or growth buyouts that allow a company to keep operating even if it doesn't have venture scale upside. It's a really compelling argument in a time when we're seeing venture evolve with new instruments, secondaries, liquidity, tools giving founders more optionality. But historically, private equity and early stage VC live in separate universes. We're starting to see a little bit of a blurring of lines between late stage growth, cross over capital and then earlier PE moves. Perhaps this becomes more of a natural step. You know, we've talked about this and how the adventure ecosystem seems to be growing up. We're seeing more continuity between early stage VC and PE firms rather than the more traditional graduations to late stage venture. Do you think that's a good thing? What kinds of relationships should early stage funds be building with downstream capital partners today?

I mean, I read through the article and I was like, yes, we already have many companies that with the best intentions will fall off the venture rocket ship. And you know, I've talked to founders who feel this same frustration, which is like, hey, I signed up for the venture capital rocketship now that I know more about my business, it isn't one of those how do I get off? And I think the author's right, we don't have a good off ramp. And I think some of this is just the Structural differences in what makes a good venture capital investment and what makes a good PE investment. And you know, we have companies in our portfolio that are trying to navigate this. They're growing, but they're not growing fast enough to maybe unlock the next round. But they're not companies that under any circumstances should be shut down. And the difficulty is actually in how do you take a company where most of the product and operating decisions that were made for the first couple of years were all oriented toward growth. The hiring plan, the product development plan, the business model, the price were all oriented towards growth. And then you have to sort of like in midair, change gears and say all the things. We were focused on growth and you know, not worried about profitability. We're going to flip our whole mindset if you want to get on that PE path, because that's a path that does prioritize financial performance, profitability, operational excellence. And you also, I think that the other thing that's missing here is for that to even be on the table, you have to hit some minimum scale. Maybe it's 10 million bucks, maybe it's 5 million bucks, maybe it's 20, there's some minimum scale. So I would argue that we have a good off ramp right now for companies that are not on the venture trajectory but are subscale. Those companies should shut down or sell. So if you can't get to a couple million in ARR and you've raised vc, the most likely outcome for your business is shut down or sale. And I think as you get to the 10 or $15 million revenue mark, it gets more interesting because then you could build a business that's more profitable that be a tuck in acquisition that could be interesting to pe. But oftentimes I find the people who are interested in signing up for fast growth are not necessarily the people who are interested in or best suited to run the more profitable, slower growing version of the same company.

Elaborating on that last part that you mentioned, at the earliest stages when we come in, have there been signals that you've seen that you can almost tell years before that perhaps divergence in the road occurs, that this could be potentially a great route for a private equity kind of path or buyout versus this is a company that's either going to shoot off and grow rocket ship wise or it'll be shut down. Because I think we're going to be starting to straddle the middle road a lot. So it'll be figuring out how to discern between the two paths quickly.

I mean Historically, the answer has been if you're a venture capitalist, you should try to screen out those companies that you think are going to get on this path and you should avoid them.

Yeah.

And when I read a lot of the things about seed strapping that people are writing, I don't know how much of that is aspirational versus it's actually actionable. There are more people I've talked to and I've come around this. We're going to have two kinds of venture backed companies. We're going to have companies that raise $10 million or and figure out how to get on their own self sustaining, ideally high growth path. And then we're have companies that raise as much money as humanly possible. And I don't think we're going to have that much in between. And the question for the companies in the middle is going to be can you still get attractive outcomes if you raise a little bit of money? I think about companies like Buffer and others that have been fairly judicious in the amount of money they've raised and are still even in our own portfolio, healthy. There are companies, I think there is not an inherent tension between being capital efficient and growing. It's funny, back in the stone ages of venture companies got profitable fairly early in their life. It was an important step to make sure that the business actually worked because you were going to take that company public someday. And we've, we're pretty far away from that.

When did that change? Can you hearken back to those days?

And about mid 2000s it's like everyone's like, well growth is more important. We'll solve profitability later. We never sort of came back to that in the venture business. There was so much more money that's coming to the business. There are people who will finance longer stretches of upside down financial performance than before. It used to be you had to fix this stuff because the next person in the chain demanded it. And now you can go pretty far in your life as a private company without solving for profitability.

My last question for this one is what role should we as early stage investors play in helping our founders navigate this decision? Is there a clear duty of care to helping them explore off ramps? Or are we still too anchored to the power law model? And is this just something that's happening now more than ever, just given all the conversation around liquidity and needs from LPs et cetera?

I don't think most VCs want to be in this business. I say this business. I mean the business of working with companies that they've invested in that are subscale. But maybe there's an alternative. I think most VCs I know want to spend their money and time on the rocket ship companies. So I do think there's this duty of care that, you know, if you made a commitment to a founder to work with them, it hopefully was a thick and thin commitment. And I wonder if firms will start to in the same way as they added board partners. I wonder if some firms will just say, hey look, these companies require a different set of resources, a different set of guidance. I want to spend my time on the high growth stuff. We're going to bring in an operating partner whose job it is to be the board member and shepherd these companies to the second path. Because I think right now the belief is that second path is a lower scale outcome path. If you get a few of those things that really pop, attention follows money and VC firms will pay a lot more attention to those companies.

Well, it's a great bridge from my point of view into our next topic. Bloomberg reported last week that Lightspeed Venture Partners has officially become a registered investment advisor and ira, joining other larger firms like Sequoia, Andreessen, Horowitz and General Catalyst and evolving beyond the traditional venture capital model. This move enables Lightspeed to invest in a broader range of assets beyond just startup equity, including secondaries, public stocks, crypto and AI led rollup without being limited to this 20% cap that typically applies to non RIA firms. This shift underscores a larger transformation in the venture ecosystem as larger firms adopt PE style strategies and blur the lines between venture capital, private equity and asset management. This reclassification reflects the growing consensus that venture capital, especially at scale, is becoming more diversified in structure, strategy and ambition, and that traditional VC alone may no longer be able to meet the expectations of LPs or the operational goals of large firms. Charles, from your perspective, are these firms setting the pace for what the future of venture looks like, or are they simply outliers playing a completely different game altogether?

I think that all of the big firms that aren't RIAs are going to become RIAs for a couple reasons. The nice thing about being what's called an exempt advisor is as long as you're a venture capital firm or no more than 20% of your activity is in the areas you mentioned, you have a much lighter regulatory compliance burden with the sec, with other regulators too. So if you're a small venture firm like Precursor, it means you don't have to have a full on compliance team and we don't have to have a compliance person editing the learning corner to make sure we're not making any forward looking or marketing. It's just easier, but it's a limiting factor. And I think this is, as you highlighted, it's a function of venture getting bigger. And you know, below a certain scale, the trade off between being exempt but being limited in the products you can offer is probably a good trade off for most firms, unless you really want to do crypto or secondaries. And now I think these firms are like, well, we're not really venture capital firms per se. We are broadly diversified asset management firms, firms that are anchored in venture capital as our core product. In the same way that like BlackRock is a multi asset firm, a lot of the PE firms have private credit arms now. And I think this opens the door for a couple things. One, you've already seen General Catalyst essentially start to acquire other venture firms. I think you will see registered investment advisor VC firms acquire other adjacent businesses. You know, two of the three firms you mentioned already have or will have wealth management practices on their own platforms. I expect they will look a lot less like venture capital firms. I also think if the management. I have no reason to believe this is true. I have no incentive information. If the management of those firms have any interest in going public or being acquired by a larger private equity firm, all the people who would buy them are registered and in order to go public they would likely need to be registered. And the last thing I'll say is it's very clear to me that the largest firms in our industry plan to continue to get bigger. And at some point the only way to get bigger is you have to have products other than venture capital under your umbrella. So I think this was like the natural evolution for these firms given their desire to grow AUM and you know, to scale.

How do you think this affects the way early ST firms like Precursor are perceived by founders and LPs is to create pressure at the GP level to expand the scope of our offerings or is staying focused still a good competitive strategy?

I think it's actually quite smart of these firms to register because at some point, you know, we've spent the last two years being like, what is venture capital? Like, what counts? And I think these firms are like, well, whatever a venture capital does is venture capital. But even that has a ceiling. So at some point you're like, we're actually not a venture capital firm. We are a broadly diversified private investor investment firm. And at some point I'm sure these Folks will dabble in other things like private credit or maybe even public equities. But at some point you're just like, we're so big that we're not just a venture capital firm. So that's the wrong label. I'm very curious to see what these folks decide to call these new businesses. Most of the terms have been pejorative and most of the pejorative terms have come from little VC funds, asset gatherers, you know, investment banks, you know, all. All designed to poke fun at their size and scale. And given how many smart people there are, I think somebody at one of those places is going to rebrand these mega funds as some new cool sounding asset in service of raising more money.

Last question here, because we talked about LPs, the GP for founders with this sort of move. What should this mean for them if they're engaging with different funds who are considering these new types of ways to diversify? And also, does it matter from their perspective?

I don't think it matters today because even though a lot of these firms are branching into other things, you know, secondaries is very much still in the lane of venture. Crypto can be, but doesn't have to be in the lane of venture. I would argue despite their size, most of these firms still have venture capital and early stage venture capital as an important piece of what they do. It's not impossible to imagine a world five to ten years from now where venture is less than half of the aum and activity at these firms. They've got so many other businesses. And then you start to ask yourself as a founder, do I want to be at a firm where venture is the main event or do I want to be an only event or do I want to be at a firm where venture is a part of what they do? Historically, founders have chosen the pure play, over the side hustle VC thing. I don't know if that will continue to be the case because if you could still get Marc Andreessen or Roloff on your board board, even though Sequoia and Andreessen are much bigger firms, I think most founders would be like, I don't care how much time he spent on, you know, Sequoia Heritage or Andreessen Perennial, as long as he's got time for my board meeting that's giving me advice, I'm in.

It makes me think about those funds that are kind of in that middle. So not small, not mega yet, where their minds will go. After seeing these mega funds create more diversified strategies around how they move money, I'M curious to know where they will lean.

I think a lot of people have deep questions about if you think about the barbell, I think most people can tell you a story about what happens on either end. I think the middle most people are like a sustainable place to live. What does it mean to be one of those firms? And I think that's the next unanswered question in venture what happens to the 350-750 million dollars Series A focused venture fund like Is that a model that works today?

In our final piece, the Information shares highlights from their recent event on the state of AI today and where investors examined whether top AI companies were the next Googles or Yahoos. Even as enormous amounts of capital are flowing into foundational models like OpenAI and Anthropic, many investors remain uncertain about things like monetization, enterprise adoption and sustainable differentiation. The piece really noted that many AI companies actually haven't found their AdWords moment yet. In other words, many companies are still using subscriptions as a stopgap as they figure out monetization and the current state of AI revenue is unpredictable. Enterprise adoption is cautious and picks and shovels infrastructure plays like GPU rental, data centers carry significant risk and then geopolitical and regulatory uncertainty only continue to add to those challenges. Across your career, Charles, you've see multiple technology cycles. Internet, cloud, mobile investors are overlaying those learnings from these past cycles as a lens to make sense of the current AI wave. But what are some of the themes from previous cycles that still hold true today?

As you know Leanne, I have a lot of maybe out of step views and I'll tell you, as I've told the team, my lesson from 2000 is everybody was pretty much directionally right about what the Internet was going to mean for the economy and society. If anything, we underestimated the potential. People hadn't really thought through really the consumer commerce opportunity of the Internet were obvious. I don't think we really knew how much we would use the Internet to communicate and I think no one I knew had really pieced together what does the Internet plus mobile mean for just like redefining communication society. And I say we were directionally right because we were totally wrong on the timeline. If you look at the just ironically the amounts of money that were lit on fire in we'll call it 97 to 2001 it felt big because the scale of the venture business was much smaller then. We could light that amount of money on fire today in venture and probably not notice this. So one Is that never confuse basically being directionally correct with getting timing right. And as I've told many of you, I have deep concerns that our enthusiasm about AI is directionally correct. But we're one generation of companies too soon for all of the pieces. And when I say all the pieces, it's not just the technology, it's the business model, it's distribution, it's user behavior. There's like a lot of things that have to, you know, I, I was talking with someone about the differences between webvan and Instacart. And aside from Instacart not having warehouses and all these other things Instacart happen after Uber, it wasn't just the technology shift. There had been a behavior shift that people were used to getting stuff delivered on their phone. There were other companies that had figured out some of the, like a lot of stuff had been figured out. And it wasn't just the technology piece. So one is a direction and timing are really important. The other thing is it oftentimes takes time to figure out where the real value capture opportunities are in a new ecosystem. And the Internet. Everyone was like, oh, I want to be infrastructure. And then it turned out that like there are people who built data centers and for a while that was a good idea. Then it turned out that building routers was a good idea. So if you were Cisco or Juniper and building the plumbing, but maybe laying fiber in the ground and trying to operate fiber wasn't as good a business, even though we really needed fiber. And I say this because when I look at AI, I don't have really any doubts that directionally it's going to be a transformative technology and probably on a faster time cycle than mobile or cloud, which I would argue were 15 to 20 year cycles before we really had the plumbing in place. But even if it's twice as fast and it takes seven years, that to me suggests there's a lot of companies that are being funded that will not make it. And the other thing is, from those other cycles is exuberance. There's a period of time where people are like, I just need to invest in this theme. And if you read that article, from the information, my takeaway is a lot of people don't have a well developed thesis on how this is all going to play out. They're just like, this is the hot thing. And my job as a venture capital investor is to invest in the hot thing and hope that when the dust settles and we figure this out that I'm in the right companies. That's really not how I operate. So we're taking the risk of just saying the alternative path is you do some investing in this theme, but you also wait until you have enough clarity around what you think works and where you think value is going to accrue that you start investing in those companies. So if you'd waited and done sort of some of the second generation Internet stuff, you would be some good companies. For example, once we knew that the web server was an important piece of the three tier architecture, they were a really great company. Once we figured out that, you know, Gen 1 website builders like Angel Fire and those weren't really that valuable, but with some squarespace, like in a lot of cases, if you waited and said there will be a better version of this thing that comes along, you could have made a lot of money.

I want to go back to that example that you had about Uber and Instacart and how Instacart started later. And that behavior change for from a consumer perspective laid the groundwork and a really strong foundation for it to be successful. What do you think needs to happen from a consumer standpoint? When we think about AI and when I think about consumer, yes, I think individual people using them, but also on the B2B side as well, companies, etc. In order for folks to feel like there's going to be a stronghold and people will know how to actually use leverage and build upon these.

I think it's kind of like Internet search. I think in the beginning people didn't know how to use the Internet. They didn't know how to use Google to search. But there was a set of people who understood Boolean operators and understood how to write a good query. And if this sounds like prompt engineering, it reminds me a lot of that there were people who were like more skilled in using the tool and those people were able to get a lot more out of it. And eventually people understood I'm going to have to know how to use this in my job and in my life. I'd argue most people still aren't that good at searching for information on the Internet. But it would be embarrassing to say you don't know how to use Google today. I don't know that it's embarrassing to say you're not good at ChatGPT today. I don't know that's embarrassing at all. I think right now the funny thing is investors and people who use this stuff a lot are reasonably skilled at getting good information out of ChatGPT and they're getting a lot of leverage out of it or anthropic or llama, whatever you want to use. But most people aren't. But most people also don't have to be good at it yet. And so I think what needs to happen is most people need to get comfortable and familiar with AI. And that might not be typing into a text box. It might be talking to a device. It might be voice is the thing that unlocks it for people. It might take Apple getting AI right to cross that Rubicon. But I think once people are like, I use AI regularly to do stuff and I think right now it's students and knowledge workers on either end are really maybe for maybe for different reasons, knowledge workers maybe out of fear and a desire to be more productive and students out of a desire to do well. I won't say to do better in school, we'll say and I think for the people in the middle it doesn't feel urgent or necessary to be good at AI yet. And I think once people are used to using it, you can take for granted that people will know what to do with AI enabled products. And I think right now that's just not true.

And there's a difference between playing around with products versus weaving them into your day to day life. There's so much more to be discussed there and I'm really excited to see how it all turns out. But we are all out of time for today. Thank you Charles for joining in. Thank you Neon for joining in as well. We will talk with everyone next week, but please like and subscribe in the meantime. Thank you. Bye bye bye.