High valuations can make even successful startups poor investments

Transcript

Transcribed by machine (Whisper) from the episode’s audio, so a word may be off here and there.

1. 23:50

   Well, I could give you the pro version of this argument. Give me both. I'll start with the negative version of this argument. And I'm not saying that this is always right. There are always exceptions to the rule. But I, my general assumption is that it's actually not true. Like there's company values at liquidity, at the point of liquidity are not going to move meaningfully beyond where they have historically. Like there will be exceptions, OpenAI, Anthropic, you know, they're going to go out at over one and a half trillion dollars market cap. And that's incredibly unusual for a tech company. But like Airbnb is worth $100 billion. Stripe is worth $150 billion. These are incredibly awesome venture outcomes.

2. 24:30

   And this belief that every AI company is going to be a trillion dollar company, there's just not enough money in the universe that there's going to be a hundred one trillion dollar companies. What ends up happening is now we have these companies that are coming in that are saying we're doing a 300 million dollar round. And we literally have to ask them, that's how much you're raising or that's the valuation?

3. 24:51

   And we don't we don't know the answer to that question. And it's just math at that point. Yeah. It's like if you're raising like pre-revenue, pre-incorporation round of 100 plus million dollars, you can just walk the math out with dilution, with capital costs, everything like that. And you basically get to the point where it's like, even if this works, like at 100 billion dollar level, we don't return the fund, which means that you require it to be a trillion dollar outcome to see the same venture dynamic that you see in a normal company 10 or 15 years ago.

4. 25:26

   And I think that there's like two problems here, and it's both on the investor side and the entrepreneur side. On the investor side, there's this belief like venture capital is far too aspirational. It doesn't make any sense. The asset class can't support 100 successes. You know, being an investor should- the enterprises that we have? No, not at the enterprises that we have right now. There are too many VCs. I think this is like just a, it's a truism. And because of that, you have all of these people that are chasing deals, knowing that they have to get in the winners to make it work.

5. 25:58

   And they're willing to pay any price to do that without recognizing that like the baseline for a successful venture fund is you have to beat the S&P 500. And at these prices, you're not, you're just not. I mean, the S&P 500 is like 25% IRR, even 20. I mean, that's not easy. easy to beat. And that's the floor for venture capital. If you don't beat the S&P 500 as an asset class, why are you putting money in venture capital? It doesn't make any sense.

6. 26:22

   And so that's like on the investor side, we have a responsibility to be disciplined and understand the bar that we're being held to by our limited partners. On the entrepreneur side, and this isn't a critique, it's like, I don't expect that they would think about this, but I genuinely don't think most entrepreneurs have thought even one second about how economics works. They just think someone is willing to give me this much money and they're willing to give it to me at this price.

7. 26:49

   Therefore, that's the market price. But there's like long, long running, long range implications and consequences from those decisions. And there's just no economic awareness of what those consequences are because no one has lived through a down round. They haven't lived through a recap. They haven't lived through getting stuck and not being able to raise. They haven't lived through an economic downturn and so it's just like you're just yeeting cash at some point because you think everything is up into the right forever and this has just never been true there will be downturns you have to be responsible in the way that you raise because otherwise you're literally playing a game of chicken with your company which is not just an organization it's people you're playing chicken with people and i think people deserve better than that like i i have a responsibility

8. 27:40

   to the 10,000 employees of Vanderell to not raise at a price that I'm not going to be able to beat the next round. That is my responsibility as a founder. And I think too often founders are just like, whatever, the market price is the market price. And it's like, man, you're playing a dangerous game. Yeah, I want to come back to the pro version in a second, but I think this is... Also, just a hard message often for investors to obviously say without sounding self-serving, which is that the price that you are setting for your round, you better be confident that you can get a healthy multiple for the round after that, right?

9. 28:15

   Because if this is the high watermark that you can anticipate for the next three or four years, that is a very hard spot to be in, particularly if you still need the capital to grow. um and then accepting the highest price right now is often kind of like it's actually a very hard thing to do and i'd say this having lived through this at dropbox we took a bunch of like super high marks and then like you know we were the first kind of uh public market so a private market decacorn i think back in 2014 or 15 but then that meant from that point onwards like it was very hard to raise capital to grow unless like you know we had insane economics and any kind of blip in the market or the product in our growth would just make it really hard. And I think we suffered through that, right? And so, but then, you know, so my story is like, it's okay to take

10. 29:02

    a 20% haircut right now, if it means that it allows you more flexibility for the future. But it's often a lesson that I think it's hard to kind of like tell people about, and they almost have to live through. But what's your positive version of kind of the AI valuation story? The positive version is that there are new market opportunities. And, you know, there are companies that wouldn't have worked 10 years ago that will absolutely work today and can be done with much smaller teams, with better margins.

11. 29:30

    I think because of that, you can kind of justify seeing average entry prices shift a little bit. And I think every venture fund has seen this. Companies like Bob's company, Arda, it's like we're willing to pay a higher price because we think that this is an enormous market and we believe in him as an entrepreneur. And so there will be some of that, but it really has to be, you really have to be dialed on chasing the right big market opportunities rather than just like being generally optimistic about AI, which I don't think is a sufficient argument.