20VC: NEW FORMAT: Harry Stebbings on Why Seed Pricing is as High as Ever, Why Series A is the Best Place to Invest Today, Why Growth Founders Need to Reshape Expectations, Why M&A Windows Remain Shut and When Will IPO Windows Crack Open

0:00Hello and welcome back to 20VC with me Harry Stebnings. Now, stay with doing a first of its kind show. At 20VC, we have the most comprehensive data on a generation of venture investors. We have over a thousand track records, over 10 ,000 references with individual MPS from founders on their investors, where they added value, where they didn't add value, how important and impactful were there as a board member. And today, we analyze the different components of the venture market and use our proprietary 20VC data to highlight some core observations and lessons. We cover everything from fundraising for funds to the growth and IPO markets.

0:35It's a very special and different show and I really want to hear your thoughts. Let me know on Twitter at Harry's Debbings and I'd love all feedback. But before we dive into the show today, listen to this. Mercury has been a breath of fresh air. Getting started was maybe one of the most delightful onboarding experiences I've had. Mercury is just so easy to use. The aesthetic is actually quite relaxing. For me, it was less a choice and more finding a kindred spirit. Imagine feeling this way about business banking. You could, if you join more than 100 ,000 startups on Mercury, the powerful and intuitive way, ambitious companies to bank, start building momentum and leave the friction behind by visiting mercury .com forward slash 20VC.

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3:11So this show is going to be unlike any other 20VC that we've done before. I recently sent out an investor update to LPs of 20VC funds and in the update I included a market commentary which essentially broke down the different aspects and components of our markets from the LP fund investing side to the seed market to the series A and B market to the growth markets, IPOs and beyond. We even touched on some elements of AI and SaaS markets today. Now, what many people do not know is that 20VC has one of the largest data repositories on this generation of managers, over a thousand track records, over 10 ,000 references on VCs.

3:48And so a lot of the information and data that you hear today is predicated on our product through 20VC data and then insider conversations with some of the world's leading investors. That is what is behind a large amount of the information that you're about to hear. And I'm really interested to hear your thoughts. So let me know what you think and we're going to kick off today at the source of capital with LP fund investing First and most importantly, despite what you read on Twitter, LPs do remain open for business The best investors in funds realize and know that you have to invest through cycles and you cannot miss being in a great fund So what is going to separate those that are able to raise and those that aren't?

4:25I think it's really three core pillars. The first is trusted relationships LPs invest in lines not dots If you are meeting an LP for the first time during your fundraise, it is very very difficult to convert them that fun cycle. And so you have to really build the relationship over time. Lines not doors. Fun fact, on that note, I meet two new LP's every single week regardless of whether I'm fundraising or not. You then want to build an LP acquisition flywheel. Flywheels drive any successful business. You need to build as a fund manager, an LP acquisition flywheel. So I meet two new investors every week, two new LPs every week and at the end, I say, it was so great to speak, I really enjoyed this.

5:07If you would recommend two others that you think would be great for me to speak to and build a relationship. Who would they be? They will recommend two more and each week you get four net new LP referrals for you to speak to to start building those relationships and initiating that line's knot dots. The second I mentioned that the thing is really important, DPI. You have to have had cash back. You have to be able to show that you You can make money for your investors and then the third is differentiation, a truly differentiated model be it on the servicing side, be it on the sourcing side, you have to have two of the three to be successful in this fundraising market to recap.

5:43Trusted relationships, DPI which is cash back, or differentiation in terms of your model for one of the three pillars of venture, the three pillars of venture, sourcing, selecting and servicing. If you can prove tangibly that you have a differentiator that allows you to do those three better, then you are significantly higher likelihood of being able to raise in this market. Now, I'm going off on a bit of a tangent here, but either one this to be as kind of free style as possible, we mentioned that kind of being successful in terms of fundraising in this market. I think the type of manager that succeeds in this market is actually different to the type of manager that is succeeded in the prior cycle.

6:18In the prior cycle, what succeeded was aspirational capital where the founders picked the source of capital. Now that is still very much the case, but there is an increasing element of picking the ability to truly pick the quality companies from the not so high quality companies. So we're seeing shift in emphasis away from the aspirational capital towards the really great pickers and then I think we'll see a shift in investing from the momentum investors that won so strong portfolio management to the incredibly diligent portfolio who are incredibly aware that actually we were lied to for many years when we were told lean in, lean in.

6:53The best actually strategically lent out of their best positions. And so I think we'll see a movement away from the momentum portfolio management liquidity management doesn't matter to actually the best returning managers being incredibly disciplined around core tenants of portfolio management, especially liquidity management. Another important trend that we see in the funding investing market for Alps today is what I'm calling the end of the barbell. Alps are moving away from the sub -hundred million dollar funds with little track record and little data. In a lot of cases given the size of their check, it's not worth their time for the risk profile attached.

7:28At the same time, Alps are moving away from the billion dollar plus funds in the knowledge that a 3x of 1 billion dollar fund is not a likely return profile. Given the downsizing of outcomes that we're seeing in public markets over the last six to 12 months. That realization of just how hard it is to do 3x plus on a billion dollar fund really hits home I think to the LP market. As a result LP is a clustering towards the 250 to 600 million dollar fund size range where funds have DPI, the team has history and there's a reliable mechanism to produce outsize returns but where they're also able to write a 20 to 25 million dollar check and be able to reinvest with them for several fund cycles.

8:09That's really where were seeing the clustering and concentration of capital in the middle actually of that barbell that we have seen over the prior years. Now we don't talk about it much, but through doing 20 VC we have an incredible amount of proprietary 20 VC data on this generation of managers. This includes track records, DPI's, TVP's and for those that may be listening who don't know what TVP and DPI is, TVP is very simply the book value of your portfolio. What is your portfolio worth on paper in the current market? It's measured in a number of different ways, but what is the book value on paper of your portfolio?

8:44And then the DPI is historically, what is your cash back to investors? How much money have you made for your investors? Cash back. That's TVPI and that's DPI for anyone wondering what those meant. As well as this incredible track record date that we have, we also have several thousand references from founders who work with VCs who sit on their boards. They provide us an NPS of what it's like to work with that VC and NPS is a net promoter score which essentially rates that venture and rest to out of 10 for the value add an impact that they've had on their business. And so there's a couple of core observations when I look at this data.

9:20The first NPS and DPI, there is an inverse correlation between the NPS of the manager and the DPI provided. Most often the higher the NPS, the lower the DPI and vice versa. There are core misalignments between founders and GPs that often aren't spoken about, but most notably around liquidity time we can't get. They often impact the managers and the investors, but are very positively impact their DPI. The second really interesting element that I'm seeing looking at the data is the temporal diversification is real. For those that deployed funds in 12 months in 2021, their average entry price is 41 % higher than those that deployed over a 3 year period.

10:02I've always believed in the power of tamper diversification myself. 20 BC was invested across three year timer horizons. I always laugh and say, I don't know how to invest fast and well. Three years, you need to have tamper diversification to have that risk profile equalized in your portfolios. The third one I would say is, as I mentioned earlier, lean in is a bit BS. A generation of managers have believed that you double down on your winners, double down on your winners, and you don't ever sell. We've been told this for the last decade, ride your winners. the data shows the opposite, the best strategically lean out of their winners in increments over time.

10:36Preparatory 20 VC data shows managers with the same positions but three X different returns due to timing and size of X to position. Managers must know their liquidity strategy. That's going to be increasingly important. The fourth one, the chasm between TVPI and DPI will be the biggest in vansher history. Vansher books remain incredibly highly marked or highly priced with portfolio companies having a lot of runway, there's no incentive for managers to actively mark down positions. We've seen this extensively across over a thousand track records that we have access to. The fifth I would say, we mentioned there about how portfolios are very highly priced still today or highly marked by their managers.

11:15A really interesting element, the best managers mark down their portfolios fastest. There is a direct correlation between the best performing DPI managers and the speed and accuracy with which they mark down their positions. Now at the sixth, I would say there's just a huge chasm in book values. As they said, we have over a thousand track records. We see immense chasms between the book values of how different managers hold positions. In some cases, we see managers marking a deck of corn, a zero, and others keeping it at a deck of corn price. This presents actually a really interesting challenge for LPs because they don't know the underlying true value of their portfolios.

11:52Now, for some that are compensated on TVPI, they actually want that book value to remain high because they are compensated on it. For others, it's a real challenge because they just don't know the underlying value of their assets that they're invested in. Now, the final one I would say is that the fund deployment slows down due to GP overextension. What do I mean by that? In order to raise the larger funds, a lot of GP's increased GP commit significantly. At the same time, they're invested in several other emerging managers and borrowed significantly against very highly priced portfolios with the carry predicated on those high prices.

12:26The combination of which means a tightening of personal finances for some and many GPs and a slowdown in capital calls due to them being on the hook. So to speak, for millions every time that a call is made. Now before we move into the seed landscape, I think really if you're an LP investing fund state you should be looking for three things in the managers that you're looking back. They should be aspirational capital and what I mean by that is they are capital that founders consistently seek out and choose to partner with over other funds. It is not simply enough being able to pick, you do also have to be sought out as aspirational capital.

13:01Second, you have to have a proven model and mechanism to do the three corpillars of venture better than other people. Sourcing, selecting and servicing. Do they have a truly differentiated model to do those three things. I think a great example of that would be Y -combinator which clearly and most handgrably has that mechanism to do those three things better than many others in the early stage ecosystem. And then I think the third core element which is really important to consider is the manager that I'm looking at or assessing are their long -term goals aligned to our long -term goals as a financing partner.

13:35What I mean by that is if a fun One today is 300 million and the manager wants to scale to 2 billion over the next 3 -5 years. They might not be aligned to your long -term financing interests. With that in mind, one in done funds is not a position that anyone wants to be in, and so just making sure that you're aligned in terms of the manager's expectations and desires in terms of expansion and your desires in terms of continuing partnering positions with them. Alright, now we're getting into the really fun stuff. We're going into the direct company investing market and we're going to start with seed investing I'm going to be incredibly unpopular for this but we're going with the roundling episode for today So seed is the hardest place to be investing today prices remain unchanged and high Increased competition as more multi -stage funds move towards seed aware that they have to be in market But they don't want to deploy large checks at series a and b There's also what I'm calling the rise of principle power.

14:32This is multi -stage money deployed by principles within firms because partners are under water with bought positions in struggling companies and they're giving more junior members of the team a checkbook. This increases the capital supply to the seed market but also means less price sensitive supply and so seed pricing is as high as ever and I think will continue to be as high as ever in the core markets. I know I've seen some data and reports that suggest this is in the case for the best deals in the best markets, pricing continues to remain incredibly high at seed and I believe we will see it stay that way over the next 6 -12 months.

15:06So yes, that means the 5 million pre -seed on a 25 million valuation still very much is the case in AI even more so. And I think it's really important to just point out, this is not a game that a sub 75 million dollar seed fund manager can play. You simply cannot get the ownership required, all the check size often in those hot rounds to make the business model work for that entry price and that check size if you're a sub 75 million dollar fund. Sadly now that is a game for the multi stage funds who are simply spreading optionality allowing themselves to have visibility on a seed market before doubling down on anything that shows any meaningful signs of traction where they then want to put in a 20 million dollar series A and lead that next round.

15:52And sadly that's a reality event should stay, where as I said 5 million on 25 still exists, but it's a game for multi stage funds who are playing an optionality game. For founders listening to this, wondering if the check size that the fund is looking to invest in their company is meaningful to the fund, a very simple, heuristical question to ask is what percent of your fund is this check going into my company? If it's under 1 or 2%, it really does not matter. If it's over one or two percent, three to four percent, then it's going to be a core position and you really matter. Once two percent, it does matter, but as I said under one percent, honestly, it really does not matter in terms of their fun position and their capital availability.

16:31And so that's a really simple question that you can ask to just understand how much of a priority in terms of capital allocation you'll be to them. Okay, so I want to move to the series A now. I think series A is actually the best risk to reward in Sertian Point in Bansha's Day. prices are significantly down at the series A. The price inflection between Seed and Series A has actually never been smaller yet the de -risking that has occurred in that chasm has never been greater. An example of this, company X raises 4 million seed on a 20 million dollar post. Scales to 3 million error are over the next 12 months.

17:05That series A's day is priced at 40 to 60 million dollars, 2 to 3 out of price increase for a significant de -risking of product market fit. That's a much more attractive insertion point in my mind than paying the 4 on 20 with very little data. The second element of series A that I think is important is just competition is heavily reduced. As mentioned, many of the multi stage funds are reluctant to deploy the 20 to 40 million dollar series A and B checks and are instead moving to seed to remain in market still writing checks but putting fewer dollars out the door. It leaves a lot of good and great companies with fewer funding options at the Series A and B.

17:43We are rocking and rolling here so we're going to move now to growth. Growth is hard but is not impossible. You have to be one of two things in growth today. Founders have to have a solid AI story. How can you leverage existing data to provide the best AI driven solutions? How does that impact upsell and that revenue retention? How does that impact margin? If you have a really great AI story, you can still pull off a great growth round at a good price or even a great price. And then I think the second element of gross founders have to reduce expectations on price when at 15 million error and above 10 to 15 net revenue deals are still on offer for fast growing SaaS companies.

18:20People are queuing out of the door to do them, but founders still have 2020 to 2022 timeframe expectations in terms of that pricing. Founders are going to need to reduce expectations on price if they don't have a great AI story but they're at 15 million in an hour with good margins, strong revenue quality, the deals can still get done but you're definitely going to see compression in terms of the pricing that those growth investors are willing to pay and that's purely a function of them actually looking at the public markets and seeing the trickle down and going well if ex company is actually only worth $5 billion in the public markets coming in and $800 million series B price with $8 million in revenue doesn't give me the upside for the risk profile that I'm taking on and that's why we're seeing the compression and pricing really at the growth, which is really becoming a bit of a crunch.

19:07So now we're going to move from growth to M &A markets. M &A markets have dried up almost completely, and I think they will continue to remain closed. For small scale M &A, anything sub -a billion dollars is too much time for corp dev teams that people responsible for buying companies and acquiring companies to engage with. Plus, they're not looking to add headcount. No one is looking to add 30 to 50 to 75 5 person companies in the headcount to their balance sheet. The only small scale aqua hires that we are seeing take place currently is acquisitions where there is incredibly desirable AI talent within the startups and incumbents are purely acquiring those companies for that AI talent and integrating them into it there existing teams.

19:51On the flip side if an acquisition is a billion dollars plus, the increased regulatory environment means that a choir is a not -engaging, aware of the likelihood that it simply won't be approved. Next, if we move on from M &A markets, we have the IPO markets. The big question is what will be the catalyst to the cracking open of IPO markets on mass? Clavio, Armin, Instacart were not enough to crack open the IPO markets. They didn't give great confidence that the IPO markets will come back in a strong and confident way. The Biblical narrow offerings were very distributed, shows the lack of institutional demand for tech IPUs today.

20:28Will Stripe, Databricks, SpaceX potentially go out next year? Will that be the breakthrough? I don't think so, I don't expect Stripe or SpaceX to go out next year, and Databricks alone won't be enough to crack open the IPO Windows. That's said, when IPO Windows do open, as Jason Lankin from Sasters said on the show before, there is a pipeline of 20 -30 SaaS companies with 200 million ARR, strong net revenue retention, and high margins that are ready to go out. Jason thinks that Windows is going to crack open H2 so the second half of 2024. I'm honestly a bit more pessimistic, I think this will be a 2025 Q1 event, but the question is what will be enough to crack them open?

21:09As I said, I think 2025 Q1 is when we really will start see the IPO Windows open again. So with IPO Windows remaining shut, the question is where do LPs, employees and funds get liquidity? We have a massive liquidity problem today. Well, it's go time for secondary markets. Today is likely one of the best ever opportunities for activity in the secondary markets and we're going to break it down according to the three different participants in these markets. Starting with funds number one, many emerging managers are sitting on significant positions which are four to seven years from liquidity but have tremendous upside.

21:45The realization that in order to raise their next fund, they need DPI again that's cash back which means now for the first time they are open to liquidity the options on some of their best positions. Now the second is LPs, the people that invest in funds. Many LPs with strong fund positions need liquidity for mandated outflows that their institution must make annually. This is often the case for endowment funds who have to commit to scholarships or upkeep of communities or facilities. As a result, they're forced to look to sell their fund positions. We've seen discounts from our data either in full or as a strip sale at as much as 70 -80 % off.

22:24The final element is employees. Employees are increasingly aware that IPO markets will remain close for the foreseeable future and any potential M &A is unlikely. Many within the best companies are looking to gain liquidity and sell part of their positions to make that happen. Looking at these three, the fundamental question then remains, what is the spread between the demand side bid and the supply side price? For the last 12 -18 months. This chasm between the bid and the ask has been too significant at chasm, with increasing awareness on the supply side, the liquidity is not coming, the chasm between price and bid is reducing.

23:00I expect some of the best secondary positions to be bored in the next 12 months. Now finally, how can we do a breakdown of the market without discussing the AI landscape stage? So these following observations are taken from inside of discussions with some of the leading minds in the AI landscape today. Number one, the impact of AI on society will produce one of the biggest opportunities of modern times. However, 99 % of the money invested into AI startups today will go to zero. These statements are not mutually exclusive. Number two, the end of horizontal startup products. In AI, access to proprietary data will be the single most important differentiator.

23:40We'll see a generation of verticalisation in order to accrue data the fastest occur. Number 3, where does the value accrue? In the short term, incumbents will accrue the most value, leveraging existing distribution to provide co -pilot products. Over the longer term, startups providing tools for new product paradigms will be best placed to win over the next 5 to 10 years. Fourth learning, co -pilot is a last -ditch attempt from incumbents. It relies on human an input and as Sarah Tavill states it well in her writing, the winners in AI will sell the work and not the services, resulting in a reduction of human involvement and increased automation.

24:18Fifth and finally, the changing business model. We will move away from a traditional per -seat SaaS model to a consumption based model, align much more closely to value and output. Now I hope you've enjoyed this show. I would really love to hear your thoughts. You can let me know on Twitter at Harry's debbings. It would be great to hear your feedback, so let me know what you think on Twitter, and I really hope that you've enjoyed this breakdown today. Again, let me know what you think. We will be back to standard programming next week, but I really want to try out a new style, a new format, give you something slightly different.

24:52So let me know what you think as I said on Twitter at Harry's Debbings, but before we leave you today. Listen to this. Mercury has been a breath of fresh air. Getting started was maybe one of the most delightful onboarding experiences I've had. Mercury is just so easy to use. The aesthetic of it is actually quite relaxing. For me, it was less a choice and more finding a kindred spirit. Imagine feeling this way about business banking. You could, if you join more than a hundred thousand startups on Mercury, the powerful and intuitive way, for ambitious companies to bank, start building momentum and leave the friction behind by visiting Mercury .com forward slash 20VC.