Jeff Morris Jr, Chapter One | Difficult Market for VCs

0:28being in Los Angeles, folks within that sector. The same is true for consumer. There's also a ton of VCs who live here and don't talk about it on Twitter, which I'll say. And so do you want to call them out? I'll leave that out of the podcast, but it's like the opposite of the Miami approach to like ecosystem building where I think it's a little bit more low key here.

1:00Welcome to Sorcery. I'm your host, Molly O'Shea, founder of Sorcery. Today, we have Jeff Morris, Jr., GP of Chapter One, a product-driven early-stage venture fund based in LA. Chapter One is backed by Sindana Capital, Sequoia, Kleiner Perkins, and Marc Andreessen. Jeff is particularly known as one of the best product leaders in the industry and previously served as a VP of product revenue and an early employee at Tinder. In the role, he led the revenue team to the number one top grossing app in the app store. He managed the business from the early days of monetization through the IPO and for several years as a public company.

1:40Jeff is a seed investor in 13 unicorns, including Mercury, Supabase, and Compound Finance. We go deep into Jeff's opinions on the current climate for emerging managers, as well as how he runs Chapter 1 as a product-oriented venture fund. This is a fun conversation and I think you'll enjoy. Hey Jeff, thanks for joining us. Hey Molly, great to be here on a Friday. So to start, I want to dig into something that was pretty juicy. You tweeted out back in May, you mentioned writing an article about emerging fund consolidation. In this tweet, you bucketed out into like three different items. So you said this could entail merging with other emerging funds, merging with other large platforms, and, well, shutting down.

2:25So based on that and the time between it all, where are you at with the article and what gave you inklings of this potential behavior? Yeah, I kind of put it out there. Sometimes I'll tweet things to see if there's general interest, like MVPing the idea of writing an article by just tweeting it out. And if people are interested enough, I'll actually write the article. But the general idea was that I'm hanging out with the merchant managers all day long. And what's happening in background conversations, I think, is a lot of uncertainty that the market, I think, generally knows there will be a shakeup.

3:03That's pretty obvious at this point, but the extent of what that might look like and also the options for GPs, I think, are things that people should talk more about. And that if we were to speak as freely about venture funds as we do startups like and view that conversation as being okay that i think it would help lps and gps understand the dynamics heading into not only 2024 but kind of like the next cycle of of venture capital because it's pretty clear like the world's changed quite a bit And so I think since I tweeted that article, there's been, even the past two weeks, some pretty interesting ideas that have come out.

3:48One was Josh Wolfe at Lux Capital wrote his quarterly letter, and he predicted that 30 % to 50 % of venture firms would cease to exist. And then Rick Zulo at Equal Ventures, who's a friend, wrote a follow-on to that, exploring the same idea. And so in terms of where I am with the article, I'm making a ton of progress. So in the past week, I had a conversation with Beezer at Sapphire, and she gave some really interesting perspectives. And then John Felix, who's been a long-time LP most recently at Allocate, we had a similar call about a week ago. And how I want to frame this is not in a scary way.

4:30Like I think the natural idea, like when people tweet these things, I think there's like a feeling of fear. I think there's an element of discussion that can lead to creative outcomes and also hopefully more creative pitches from GPs. Because I think GPs are now being forced to answer a lot of really hard questions about why they should exist in a really crowded market. And that's led to, I think, just sharper products for founders and LPs. So, yeah, it's a really interesting topic. honestly like like so different from what the conversation was in 2021 and and 2019 when i started chapter one but i feel like we've all been through many market cycles at this point this is just like the current state of the market can you share any of the highlights from your conversations with bezer yeah i think she she did a really great job of like um trying to distinguish like there's so many venture funds and so you can think of of just like one really easy way to draw a line would be venture funds that have raised institutional capital and have like that level of backing.

5:36And generally speaking, those funds tend to be a bit more insulated from potential shutdowns, just based on the idea that that capital is a bit more staking, dependable through different market cycles. Not to say that institutional LPs don't have their own liquidity challenges and are definitely kind of starting to see some churn amongst LP bases that I'm hearing in the background of institutional piece who are not re-upping in some cases, but there, so there's that group. So if you were an emerging manager, say 2019 through 21, and you have endowments or universities or pension funds, whatever it might be as, as your backers, like you're probably in a better position today than a lot of managers who I think maybe they weren't ready for that, or maybe they didn't spend the time to go through that process, But whether you raise a rolling fund or you have high net worths or family offices or a lot of sub$30 million funds, I think we're able to stitch together LP capital in non-institutional ways.

6:40I think that's tough because you're having to go back to those folks. So maybe you're on a fund three or raising a fund three with limited DPI. And the reality of it is like those folks are just less dedicated to the space through every market cycle and have their own liquidity challenges, which is very real. And so I think that contraction will see a greater percent of those funds go out of business. But if you're again, you have institutional backers, you're in a better position today. Got it. And maybe before we dive into some more questions on this, it would be good to define what an emerging manager is.

7:17So do you mean emerging manager by the size of the fund, by how many years, the vintage? How are you defining it? Yeah, it's actually a really good question because I don't think there's an industry definition. You know, I kind of think of it as being personally just like without applying too many guardrails, think of it as being a fund that was started in the last five years that's probably on their second to third fund. There's better definitions to be clear. And so I've heard like I think it was Roger Enberg defined it as any fund that's returned 1x DPI on all capital they've raised to date.

7:49And so you stop being an emerging manager when you actually return every single dollar you've raised, you distribute back to your LPs, then you graduate from emerging manager status. I don't know if that definition is what everyone thinks of, but it was just a way to apply some metrics to the idea. But I think it's, for me, it's a newer venture fund that has come to market in the past five years that's trying to become franchise. And so ultimately, I think that's the goal if you're starting a firm is to really build a sustainable franchise. And there's some point where that becomes a reality. And until you find that level of kind of business stability through your LP base and through kind of that foundation, you're not quite there as a franchise.

8:32That's a really good definition, actually. I don't know if I heard that kind of explanation before. I want to dig into a number of things based off of the tweet. So what are the current conditions for emerging managers? Yeah, I mean, I think it depends. But for the most part, ask on the LP side, generally speaking, is they want to see DPI. Like that's just the no longer do you walk into a pitch meeting and show your multiple on invested capital or even like TVPI. Like you have to like just show DPI and be really clear what that number is. And I think the reality is for most emerging managers in call it like fund two or three, If you just look at the M &A market and IPOs, there's not obvious solutions for the DPI challenge today.

9:26It's out of secondary markets, which are, again, you're taking probably like a 40 % discount as a baseline on your positions to show DPI. year, I think a lot of emerging managers are kind of caught in this market cycle where they're in their teenage years as venture funds, like these awkward teenage years, and they're just like waiting for DPI. And that can come in different ways, but that's ultimately like the real unlock there just needs to be like an IPO window or an IPO market that's more healthy in a less restrictive M &A market because also the regulatory constraints on M &A right now are obviously a blocker to allow that.

10:11There are emerging managers who are coming to market with new funds. So call it like a 20, 23 plus emerging manager who I think has the benefit of not getting caught up in what's been a really challenging market cycle. And so if you're just starting a fund today and you're spinning out of a larger venture platform or graduating from a really relevant founder network, you might have a good story to tell. And you can also kind of shape your product around all the, I guess, missteps of venture emerging managers from the last vintage. So there's kind of like a shiny new product element to raising a fund one that I've seen some GPs benefit from.

10:54If you're just a newer investor or less proven track record in your story is not super compelling, it's going to be remarkably hard to raise a fun one, which I think is healthy, but ultimately like it's hard. And so I think I get a lot of emails and phone calls from people just trying to ask the very basic questions of how to raise a fun one. And I'm pretty honest with most people, if they're not, if their story is not compelling, like it might not be the best idea. And some of these people likely would be like maybe principals that, you know, like a venture platform. I'm also seeing a lot of people spinning out of like, call them like non-general partners, trying to spin out of larger venture platforms and start their own funds.

11:38And that's pretty interesting because a lot of these folks I think are early to mid-career and maybe don't have like that really big outlier success story they can tell. But I think that they feel like they kind of earned the right to raise a first fund because they have some brand name, multi-stage venture name to their resume. It's hard to say whether that's a good idea or a bad idea. It's very case-dependent, but I think smart LPs are able to really dig into attribution and track record and figure out the motivations and the reasons why those folks are selling venture funds. And it can't just be because you didn't make partner at X multi-stage venture fund because that's not a reason to raise a venture fund.

12:20And also probably the part of the market that people haven't talked about too is a lot of the larger venture platforms are, they're not hiring huge amounts of investors right now. And in fact, a lot of folks are leaving those platforms. And so, you know, what do you do if you're a mid-career and you're leaving a large venture platform and you don't have, you didn't make general partner. And maybe you don't have like a ton of operating experience. Like that's a pretty challenging place to be career-wise. And so seeing some examples of that. Interesting, yeah. Even, I know this wasn't something we were going to discuss, but one of the things that's been a common conversation among friends at other funds and partners and things that I've seen in my day, though I'm not a GP or anything, is partners quite quitting and starting to look other places.

13:06And you start to know when it's happening. But no, that's a real thing. Partners leaving large funds and all of that. In terms of the emerging manager funds that are out there that are in a really harsh environment, of the three buckets that you mentioned, consolidating with other emerging GPs, consolidating with larger platforms, and just shutting down. You can be anonymous. You don't have to share any specific names unless you want to. I'm sure people would love it. But could you share some examples of that and if there's been any sort of creative options or what you would actually propose maybe?

13:42Yeah. So I'll just give some recent examples, maybe on the more interesting side of things that I find compelling. And then we can talk historically about things that maybe haven't worked. And again, I credit folks like Beezer who've helped me kind of like market map some of these historical examples. But so the recent examples I think are most interesting would be like Ethan from Bessemer, Christina Shen from Andreessen Horwitz, and Mark Goldberg from Index Ventures joining, leaving those large platforms to form like a real partnership, right? And so those are people who worked, some of them worked together historically, but then they competed against each other and they saw some gap in the market.

14:21And rather than going out and raising, like the easy thing to do probably for them would have been to go raise smaller funds as solo GPs. But somehow like the stars aligned and they came together. It's really hard to do. And so that's one version of consolidation is, hey, we're going to leave our large platforms and start something together. The other form of consolidation, which I've mentioned is like a more common conversation, again, hard to do, would be emerging managers coming together. Hey, we'll get right back to the conversation after a word from our sponsor. Sorcery is brought to you by Archer.

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15:30Visit Archer.com. So maybe you have either a vertically aligned thesis and you think one plus one equals three, or you have very specific verticals that you cover that would make a really compelling partnership. And so we've seen that historically with things like Variant in crypto, when Lee joined Variant. I think I've seen that version of conversations. I've been approached so many times to explore that conversation. The reality is it's very hard to make the timing work and to make this story, I guess, to really find that one plus one equals three story. That would market well to both founders and LPs, but more importantly, that would make your firm better, right?

16:16It's just hard. It's hard culturally to do. The examples, I think, that didn't work historically was, so there was one point where Social Capital tried to join Kleiner Perkins. For a variety of reasons, that didn't work. Mamoon ended up joining Kleiner and is now managing the fund. And so they spun out to do that. And then Bieser had mentioned Bonfire Ventures, which is a Los Angeles venture fund. It was a consolidation. Mark at Bonfire, a bit more under the radar, but that was one example. The last example, which is pretty interesting too, would be larger platforms acquiring smaller funds. So they could be vertical specific funds or geographical focus funds.

16:55So the kind of the general catalyst example acquiring La Familia was one example of acquiring an international focused fund. I, without naming too many names, and this has been less recent, but call it within the past three years, we've been approached by at least one major multi-stage platform to be their seed fund, which for a variety of reasons, we just didn't happen. No timing was really hard. We, and culture obviously was very hard, but the first thing was timing. We just raise our fund to and we felt really strongly that we wanted to commit to that and do that really well. Probably would have been, candidly, a much easier financial path for me, being a big salary, cushy job, whatever.

17:38But we resisted that at that moment in time, although it would have been really interesting. And so examples like that, I think, are worth talking about. That's wild. I don't even know how that would work. So how would you structure something like that? how do you manage the incentives? Obviously, as a solo GP, you have lots of carry, you have so much opportunity, you have pretty much uncapped upside and then face the music one way or another. How would you mesh those incentives together, whether it's compensation or the actual culture and that kind of thing? Yeah, I think the long-term solution would be you would just eventually effectively shut down whatever venture fund was being acquired and be a part of that platform.

18:23In terms of where it would start, it would look more on the surface like a partnership with some shared carry and upside for the GP who's being acquired within that multi-stage funds broader platform. So all their fund vehicles you'd get exposure to and you'd be giving up some amount of your carry, probably a significant amount, maybe up to like half your upside to that platform. But I think it's, I think these were just creative ways for larger platforms to explore expanding their reach in teams. Especially in 2021, there was an arms race to grow amongst multi-stage funds. I think that was what was driving some of these conversations, but the structural piece is very hard to get right.

19:13And I think the harder piece to if you're managing an existing LP base would be to go to those LPs and get them really excited about at least in the current fund that being a great outcome for them because if you're going through some M &A effectively like an M &A process or some partnership with another venture fund and trying to deploy your fund like something's probably gonna gonna give and you might also be you might be tempted to deploy that current fund faster to get to kind of create like a fresh slate or a blank page to pursue like the next thing and so all these things are are considerations the argument for is like it's just so hard for emerging managers to stand out and so having the if it was the right multi-state platform having that partnership in place could really accelerate your your path towards being highly relevant and winning deals and kind of becoming like a franchise much faster.

20:07And so like why, why I even like had a conversation or thought that was an interesting idea is like, ultimately, if your goal is to generate the best returns and work with the best founders, like there are ways to accelerate that potentially. There really aren't a ton of shortcuts to building a venture franchise. Like you have to invest well and return capital over maybe a 10 to 15 year life cycle. And so that if there are any ways to accelerate that, like that can be interesting for a GP and potentially for their LPs too. It is extremely hard to accelerate something with such a long time horizon of even knowing what the outcomes are.

20:49Wow. That's a good point. Okay. So I want to set the stage here. I have some numbers. Nice. Okay. I pulled together there's some data from the NVCA 2023 report. I think they got some of their data from PitchBook. I will share it. But this is quite interesting because I had no idea there were so many funds in existence and it really swelled in like 2021. Okay. So for some data by 2023, there are estimated around 7 ,200 venture funds in existence. The active number of investors swelled in 2021 to over 20K people. And this is a cottage industry. By 2023, it halved to about 11 ,000. So to be more specific in terms of venture, in 2021, the active number of VCs was around 6 ,000.

21:47Now it's around 4 ,600. It's still very high, but it's dropping to pre-COVID levels. The normalized number over the last 10 years pre-COVID was just a little over 2 ,500 for active global investors, VC investors, and around 2K for US VC investors. Do those numbers sound right to you? Given you've been in the industry for quite some time, how many calls with investors have you had? Have you noticed someone picking up the phone, their email's gone. What are you seeing? Yeah, I think the reality is you're still managing. When you don't raise your next fund, you're still managing a portfolio. So nobody, and you've seen this with Shasta Ventures is a good example.

22:31Their website's still up as far as I know. And they're not actively deploying new funds today, but you're still managing a portfolio. And so I haven't seen firm shutdowns where literally people's emails aren't going through. I have seen people choose to go down different career paths. So some folks decide to go back to operating and they'll go get a really interesting job on their operating set. So you don't have to go through the public announcement of shutting down a venture fund because you're just kind of like, what's next? The numbers do sound right to me. again like i think i think um at least like the data i've seen is only 17 of venture funds make it to fund four and so if you're just to like build some like excel waterfall of graduation rates of new funds during that vintage and then kind of map it out to where that consolidation is happening it would probably line up pretty well but i don't think again this data is all like the data is very hard to get right because like pitch book or crunch base isn't announcing fund shutdown so i don't even know like where that data comes from unless there's like some rules that you were to apply like hey if you haven't raised a fund in x number of years call it five years like we'll assume you're done um but this is like very lagging it's like lagging data sets, right?

24:02It's very strange because I don't think we'll ever see the story reported in its entirety in an accurate way, but it's more directional, I think, at this point. Yeah. I don't even know how they count the number of active investors. Is that related to the fund? Is it for GPs? Is it total headcount of investors on the team? What was your number that you mentioned? So the active number of investors in 2021, it was around 6 ,000 for global and 4 ,600 for the US. Got it. It's funny. I don't know. I looked up because I was trying to market size the number of VCs and I'd seen something close to 50 ,000.

24:50But again, that could be angel investors, everything included. But yeah, maybe if you were to really look at venture funds, anybody above call$20 or$30 million, it ends up being a much smaller number. Yeah. Yeah. It probably does incorporate angel investors. It's interesting. So if that is the case and those are the numbers, where do you expect it to fall this year and next year? Do you think it'll normalize back down to around, I don't know, let's say like 2K? Like how many funds do we think will exist given some people are taking haircuts of anywhere between 30 to 50? And I've also heard like 70 % of funds are going to go away.

25:33Yeah, I think I kind of go back to what Beezer said and like really emphasize the definition of a venture fund and maybe drawing on the line on that institutional side of things. Like, do you have institutional backers? Non-institutional venture funds, I think the majority of them call it, I think that 40 % number would be on the lower end of people who I think won't be raising additional funds in the next cycle. And so, again, I don't know exactly where the number will end, but if you don't have institutional LPs, I think it's going to be challenging or maybe you just have to raise a much smaller fund.

26:16There is a certain element of at what point should you just go explore other ideas? Because as these really small funds, unless you have some financial cushion, it becomes a question like the opportunity costs financially is pretty great if you're doing high upside, obviously. But you have to really, really, really love this job because if you are just doing it because you think being a venture capitalist is a glamorous job, at some point it becomes really unglamorous and you have to just love the job. There's some founders, you probably meet this from investing, that literally the idea of doing anything else with their lives just is not an option.

26:57And I'd imagine there'll be some versions of that with the Emerging Manager Group where maybe they'll get creative, they'll come up with a side hustle, So they'll do some like media company or something else to bring. There you go. But you'll come up with different ways to kind of create enough revenue for yourself where you can do either a smaller fund or SPVs. I've seen that too, like fund managers who can't raise next funds, leaning more into SPVs. Again, these are hard things to do just on a lifestyle level. if you live in a major city where a lot of venture capitalists are expected to live.

27:37But if that's what you love to do, there's probably ways to make it happen. The last thing on that is a lot of the cohort from 2019, like people are getting older and starting families, like having different lifestyle changes that, again, like it gets harder and the kind of career risk or the opportunity costs becomes a huge question for, I think, a lot of people. Yeah, that's a fair point and a big factor too. It is, I don't, I think like a lot of people forget the financial point of it because if you raise like a$20,$50 million fund, like there's only so much capital left to like actually support yourself and if you can get a team and that kind of thing after legal fees and all of that sort of stuff.

28:28But it's a real factor. I would say, given your experience and some of the research that you've done, you're a founder of a fund, you're a managing partner. What do you think is the biggest limiting factor for fund managers as they grow? Is it sourcing? Is it access to deals? Is it like endurance? What do you think those things are? So there's a couple of things here, but the markets are so dynamic and technology changes so quickly. I think the biggest challenge for an emerging fund, especially if it's a small team, call it like a one to three person team, is relevance. And so the 2019 fund managers, a lot of, I'm including like everyone in my cohort brought their funds to market at a very different time in the technology industry where if you think about the things, like think about the trends that mattered, like the type of companies founders were building, like that's changed pretty dramatically over the past five years and especially the past two years.

29:33And so, you know, I think the biggest thing is like you can raise venture funds to some degree if you've done a good job and have happy LPs. But if you really dig deep in your soul and ask yourself, like, are we on track to being top tier venture fund, whatever you're building, You have to be convinced to do this if you want to perform at a high level that you're on that path. And if you're not, you should make changes to whatever you're doing and iterate your strategy to try to find that level of product market fit. And so the biggest question we ask ourselves at Chapter 1 is just like, what is our product market fit?

30:13And do we need to iterate or pivot or change our strategy to get there? And we're very okay doing that as long as we feel like we're qualified to, like, we're the right people to make that adjustment to whatever we're doing. Or do we need to change parts of our team composition to accomplish that? But, yeah, so I think that's a long way of saying, like, I think relevance is very hard. If you're Sequoia or name your large, amazing venture platform, I think you're naturally going to have the ability to persist through those cycles and hire the right people and make those adjustments. If you're an emerging manager and you have limited management fees, it's just you and maybe two other people.