Dave Mcclure & Jordan Stein on YC, "Spray and Pray", and Games VCs Play | E1923

27:40No, no. The majority of them will go to another accelerator. We know because we are now moving our dates to the week after YC sends out their confirmations. We don't really need to compete with them if 99 plus percent don't get accepted. So many of them will go to another program. And we've had many successful ones come to our program and become unicorns or, you know, sent a million valuation companies already. So there's plenty of opportunity for those folks to go to other programs than they would. I think there should be more competition for YC. And I think, who is the guy who they attacked again?

28:22Partobi. Ali Partobi. I think he doubled their deal. I think he offered 250 for 7%. And once he did that, that really upset them. And they really went after him hard. So if you could get twice the economics from him, he knows a lot of people. He's got a smaller size. I would actually advise going to his program. And I think a lot of founders did. I think that's why they were threatened by it, because he just doubled their economics. If you double YC's economics, you would peel away a third of the companies, I think, with a reasonable product. I think YC has a really strong value add for their program.

28:57And so it's not always just based on the economics and the numbers. I think they've built a brand that sort of feels like Harvard or your brand, whatever you want to pick. And so you can compete with them, but you have to be the Stanford alternative in your field, or you have to find your piece of the ecosystem that is attractive. um i think jason one of your points i i would say people have been competing around dollar sizes they haven't really been competing around equity portion i think there's it's probably room for someone to compete by cutting the equity down to like two to three percent um even if they offered a smaller check even if they offered a smaller check you know i think you could probably have an interesting program if you offered the same amount of money for three percent um you know Yeah, you go the other way.

29:46We actually realized that in the market. I was talking to pioneer.app. So this is a really interesting concept. And I had the founder on This Week in Startups at one point, pioneer.app. And they weren't originally offering money. And I said, you know, you have all these people doing this like virtual accelerator. Why don't you just give them 10K for, you know, 1 % or something, right? and see how that goes. And they were like, oh, that's interesting. And so then I started doing it. So we offer people at Foundry University their first check, if they haven't raised money before, 25K for 2.5%,$1 million valuation.

30:28And we did it as an experiment and we put it on their weekly check-in form, Dave. And when we did, 60 % of people asked for the 25K check. 60%. So I read it like an experiment. I was like, lean startup. Hey, would you like this? We've done, I think, 80 of those checks so far. uh so there is definitely like the first check-in 25k we're not incorporated yet we're just two or three co-founders you know with a business plan or a mock-up uh people will take that 25k check i've confirmed it in the market i'm glad i'm not in that business anymore it's very good it's a lot of work i'll tell you that it's exhausting i can tell you because i'm exhausted sometimes it is exhausting i would agree if you find good people if you have a value proposition that's differentiated.

31:12Particularly these days, I would say competing on a vertical focus or geographic focus makes a difference. You need to have a real place to add value, whether that's on product, on growth, on people. But if you can really deliver on that, then I think you can be still competitive. And people who are complaining about Y Combinator or the terms they get or the price of companies coming out, just create a competitor. That's what I did. and we get into deals at the same terms as them or earlier and we have our own proprietary deal flow. So do the hard work like Dave did, like I did. There's no need to complain about them.

31:52You can just compete against them and you will succeed because 99 % don't get in. There's a lot of successful people in the country who didn't go to Harvard, by the way. I know it sounds crazy. And again, I think just people need to recognize that PG did an amazing job with Jessica getting it started. Sam took over, did a great job. Michael Siebel did a great job. I think Jeff, sorry, forgetting, also ran it for a little while. And Gary is new, but he's not really new. He was also a YC founder and he was running initialized for a bunch of years. So they've had a great string of quarterbacks, if you will, running that program over there for 20 years.

32:33Moving on, CARTA is reporting that capital call requests hit a high in January, not seen since Q2 2022, signaling a return of VC bullishness. Capital calls are a leading indicator in that they represent a VC firm's expectations to invest capital in the near future. Jordan, as an active LP in the market, are you seeing more capital call requests in this environment? We are seeing some. Look, our sample size isn't huge. In our first fund, we invested in 16 managers. We just actually launched our next fund last week. And so still getting that geared up. But we are seeing a slight increase. It's nothing crazy dramatic.

33:17I think that there's probably a few reasons for it. But number one, I think there's a ton of money going into AI, as we all know. And so I think there's a little bit of a frenzy there and a little bit of a hype there. And I don't think that's going to slow down in the near future. I think there's a little bit of, okay, we're through a bit of the uncertainty in the market, right? Whether it's going to be a soft landing, a hard landing, you're seeing signaling of interest rates getting cut. And so from my perspective, I think investor confidence is getting higher. And that's driving some of this.

33:48I think it's probably also an element of companies that fundraised in 2021 that have held off for as long as they can and are coming back. And you're going to have to make some decisions around, do you re-up in those companies and double down or do you not? And so I think it's real. I think all of that is contributing to what's happening. Have we seen a 2x or a 3x in capital calls? No, but there is a probably statistically meaningful increase that we've observed, I'd say, over the last quarter. Dave, your fund, Practical, is a secondary fund where you take advantage of different macroeconomic conditions, including the lack of liquidity and the lack of LP capital.

34:28How are you playing the macroeconomic conditions today? Well, I think it's pretty simple. The macro condition going on is that nobody's gotten any liquidity for the last two years. And so people need to find an alternate path to liquidity that's not from IPOs or acquisitions, although we're starting to see some IPOs again. I think the secondary market's always been an interesting place for people to look for liquidity. It's been around for 20, 30 years in private equity. It's even been around a pretty long time in venture. but what we are seeing more of now is funds looking for liquidity not just individual company founders and investors looking for liquidity so you know there's certainly a pretty active marketplace for individual company secondary whether that's forge or equity zen which was a 500 startups portfolio company and others but there's not a lot of places to go find fund secondary positions or LP and GP positions.

35:30And what we've kind of found is at least below a certain ticket size, other larger secondary players like Industry Ventures and Stepstone, which acquired Greenspring, those folks are writing$30,$40,$50 million checks. There's not as many people doing sub$10 million, certainly sub$5 million tickets, at least at the fund level. So what we kind of found, and this was partially myself as a customer, I was looking for some partial liquidity in my carry in my first two funds at 500 about four or five years ago. There just weren't very many people who were buyers, at least at that time, and I would say still.

36:09If you're looking at non-institutional investors in funds, every so often those folks need liquidity. You're sending kids to college. You want to buy a house in Silicon Valley. if you're talking about a family office they might go through death divorce or retirement and there might be some restructuring in some of their you know venture assets it's not really a solution that's as needed for institutional players who can be patient and long term but for you know the smaller lps and sometimes for emerging managers who are still in their first 10 years they're probably going to be looking for liquidity particularly after going through you know, the last two years.

36:48One thing I will say, you know, we incorporate secondaries into our strategy in terms of our fund. And one of the things that we've noticed in terms of why we believe there is a little bit of a sort of lack of participation or there has been historically is it's often really hard to get information. And from my perspective, you know, if you're a part of that ecosystem and if, you know, part of that fabric, then you can get behind the door. If you're underwriting, you know, a portfolio or a single asset, if you don't have a relationship with the GP who's the investor in it, and you're trying to buy a piece from someone else, sometimes that GP will say, well, I don't, if you want to do the transaction, sure, but I'm not going to spend time to help you understand where this company is or isn't.

37:30And so we've kind of put that as a filter from our perspective of like, okay, we're not going to engage unless we're already, you know, have a relationship with a manager. And so I think to be successful, you really have to have those relationships. And a lot of those smaller dollars that you're referencing and talking about, there's no way for them, unless they're otherwise involved in the VC ecosystem, to really get behind that curtain and that wall and understand it. So I think that also impacts the decision-making a lot more than it would in other asset classes. Yeah, and I think even within secondary, there's a big difference between what's called direct or company secondary and the strip sales, which are really portfolio secondary.

38:10You know, there's a lot of people who, you know, both professional and, you know, I would say the tourist investors who are looking at individual company secondary and because these marketplaces have, you know, interesting names on them. People, there's lots of people who want to get into, let's say, you know, Stripe or SpaceX or Canva or something like that. That's very well known. um but again like you said you're not really even going to know about portfolio secondary deals unless you're part of the ecosystem and have relationships there you're going to need consent from the general partner of the fund you're buying into if you want to do that so you have to be an acceptable investor to them uh you're evaluating a basket of assets not a single asset and so you have to underwrite multiple uh companies and then you also have to think about like what's the exit trajectory for those vehicles.

38:59So it's a lot more complicated to do portfolio secondary than individual company secondary. But that said, for folks who are willing to go after it, because there's so few people doing it, you can get some really good pricing and arbitrage on that as a buyer. Okay, everybody, it's your boy J. Cal here. And I've talked a lot on This Week in Startups about how the smartest startups are shifting their engineering firepower to Latin America to boost their efficiency. It just makes sense. You just think about how many amazing developers there are in Latin America, and they're on the same time zone.

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40:23How generous. Thanks to the team at CuraTech. Jason, you're in 24 funds yourself. Are you seeing more bullishness with these capital calls? No, it's pretty consistent. I have to say it was a little bit slow last year. I think I saw some funds weren't drawing down, but I think it's pretty consistent. And it's not enough that I would notice it when I make a commitment. It's typically somewhere from 25K for these$5 to$10 million dollar funds 50 you know k one percent of the fund all the way up to 500k maybe when i do these for my family office and yeah i kind of have that money set aside so i don't even notice this this you know minor spike i do think what it shows more than anything is that uh vcs the general partners at these firms have dealt with a lot of the triage that was going on in their portfolio.

41:15So just anecdotally, speaking to other VCs on a regular basis, being on the board of some companies, there were a lot of companies that needed to do a big riff, like two thirds of the company. And instead of doing a two thirds riff, like Elon did at Twitter, they did a 10 % riff, a 20 % riff, and then a 30 % riff, and then a 10 % performance riff. And this occurred over 18 months of finally working with the founders to accept the reality that they didn't need 400 people for a$10 million ARR company. They needed more like 75 people or 100 people max, right? And so there was a lot of that going on, which I think was a distraction from putting money into new companies.

42:02And I think, Jordan, you said there was just some overhang, right? And I assume you were talking about valuations and getting reset and coming back to reality. So I feel like four out of five or nine out of 10 of my challenged companies, the challenge has been resolved either by shutdown, an acqui-hire, or a right-sizing of the company. Do you think we're done with that? Because I'm not sure we're done with it. I think that the active management of turning the corner has probably been done by many companies, but the ultimate shutdown decisions. I think that's, we're still going to see a lot of that.

42:42I was talking to a friend over at SVB and two, three years ago, there was an article last year that was written by Elad Gill about when these companies were going to run out of money. And he was talking about how a lot of those companies had raised so much cash in 2020 and 21, even though burn was high. Those companies had three, four, maybe even five years of runway. once the downturn hit everybody started trying to reduce their burn and they extended even further and so you know i spoke to someone at svb a few months ago they said finally uh the average company was down below 18 months of cash um and so my guess is we're still going to see a lot of blood in the water this year and possibly into 25 where people have to make decisions now like when you have three years of cash, even if you're trying to cut, like you said, you're not feeling like, oh, I have to figure this out tomorrow.

43:38You know, this isn't, by the way, an issue isolated to venture. You have this wild, wild situation and public biotech companies where some public biotech companies, their drug has failed, and they're sitting on$100 million. And basically, public shareholders have to come in and do a hostile takeover and do some kind of negotiated agreement. It's wild times. Yeah, it's a common thing. But see, the thing there is that at least for public companies, those valuations get reset based on what people know about the companies. In private markets, they're not getting reset. And so what's happening is VCs, we're all sinners.

44:17We're all liars. Almost every VC that I know is still holding their portfolios at valuations set in 2020 and 2021. The first thing that we say when we talk to people about assessing value in their portfolios is, have you done any proactive markdowns after Q1-22? And if the answer is no, which is pretty much what it is for most of them, we're like, well, your portfolio is probably overvalued by at least 50%. You should be reducing or cutting by 30%, 40%. Jordan, how do you look at that? You have multiple funds in the same company. You see them carrying at different levels. How do you look at that?

44:51you have a really interesting conversation with one of the two managers usually. And you say, hey, let's talk about this because this doesn't make sense to me. And one of your co-investors is holding it at a lower valuation. And frankly, given what's going on in the environment, and then they usually give you some line about how their policy, you know, extended in six months. And so they haven't proactively done it because they want to maintain a policy, which makes them more conservative and consistent and all of that. Especially if they're fundraising. Yeah, exactly. Exactly. That's an interesting point, too, is honestly, the ones who are fundraising are usually the ones who wait the longest to take the mark down.

45:26But truthfully, it's been a really important tool in our toolkit, especially in this environment, to try and understand the real value of these underlying portfolios. And so, you know, one of the things we've tried to do is whenever we're speaking with a manager, you know, we're trying to understand that information and be able to reference it later. So that if we're looking at, you know, fund manager X, we're going to say, wait a second, we've seen these few companies before. And in fact, they were marked with this. And so I think, like I said, sometimes it ends up being an interesting conversation.

45:56But honestly, the vast majority of the time, it's like, yeah, it's just our policy and we're being consistent. Don't you want us to be consistent? And it's like, well, no, I need to be honest and realistic, but that's how it goes. Mark to market. I want you to assess a fair market valuation. I guess this is the point that I kind of want to make, though, is the reason that these companies haven't been marked down is because there's no market pricing activities that are forcing them to do so. Unless these companies get sold, go IPO, do a down round or shut down, those are not market pricing events.

46:26And even if they're funding them, they're bridging them on notes that are not really setting a price, particularly for the folks who are bridging their own companies. They don't want to price them to where they really should be because then they'd have to remark their own portfolios. And if they're fundraising, that might mean bringing a 3 or 4 or 5x portfolio down to maybe only a 2 or a 2.5x portfolio. The other thing I would say is we're pretty actively trying to pay attention to where secondaries are at. And that can be an indicator too, right? If something is trading actively on a secondary market, doesn't force repricing, but it does allow you to ask the question and say, someone's paying this for this asset.

47:03Yeah. And the fact that people are even paying anything for private market companies, like I'll get some lowball offers for some of our companies. And I'm like, oh, well, that's great that there's a trade occurring at all. you know the fact that somebody may not even be a price yeah yeah yeah because in some cases people are like well yeah i'm not going to invest in that company the overhang is too too large i have been getting a number of some founders have taken it very seriously getting to profitability or break even so i've started to get the infinity sign in months of runway we are infinitely uh our number of months of runway is infinity and i'm like well that's charming and awesome great um and then hope renews and which is what's happening and people say oh well if you're growing you're at infinite and you've got five million in the bank great you're making three million a year great what's the number going to be next year and they're like four million we're like oh okay can we have a conversation about growing faster and losing some money so here we go again you know the cycle growth over profitability oh my gosh here we go and i and literally 19 this i think like the the second half of this year is going to be um growth and uh reasonable investment aka losses reasonable burn in order to hit you know more aggressive growth topics because i think everybody was just like batting down the hatches let's make sure that our ship doesn't crash into the rocks okay the storm's over okay feels like okay it could be choppy water but it feels like the storm's over okay we're out of the storm okay now let's have let's let's start a plan to grow this thing again and i think that was hard for a lot of people and i'll just make a note to folks and i've experienced it in my own career man uh moderate success is as bad or more pernicious to break out success and is more of a blocker than no success because if you have no success you just shut the company down it didn't work failed experiment we all move on you get to three four five million dollars in revenue you get this like tweener company okay great we got to three million but we can't move it up the the revenue is not coming okay great what do we do and you're like well we have a three million dollar business let's try this strategy to grow let's try this strategy to grow and you just may have hit like the natural audience and you got to really that's a tough one for founders is what do you do with the three million dollar five million dollar ten million dollar success quote unquote but it's not a venture success Have you seen any of those break out or they all stay middling?

49:36I don't think it ever. Yeah, they just have to get sold. They have to get sold, spun out. I have a favorite expression to describe the situation, which is usually winners keep winning, losers keep losing, and tweeners keep tweening. And it's very hard to move a tweener to a winner. I think in a few cases, you can pick your battles and try and get some folks back onto a growth path. but I would agree with Jason. Again, this really depends. From an investor perspective, something might not be a win that from an operator perspective could be a win. If you've got a company doing 10 million in revenue, generating 1 to 2 million in profits with modest growth, that's probably not a win for an investor.

50:16That could be a great business for the operator. So it really does depend on your perspective there. And that's where the difficult conversation of buying out the investors has to occur. so they can at least take the loss or wind down a fund. When funds get to 15 years, people just, my understanding is buy the shares, have their shares bought back for$1 from the failed investments or just try to sell them in a strip maybe to Dave. Or no, do you find yourself? That's not where we buy. We're generally buyers around the seven-year mark. So our optimization is for when we look for funds that are doing well, where the losers have been written off and winners have emerged.

50:59Probably, let's say it's somewhere between Series B and D, $30 million to$50 million and up in revenue. But there's a whole other business in secondary that's kind of like wrapping up end-of-life vehicles, establishing continuity vehicles. It probably happens between years 10 to 15. And generally, we sort of bump up against that, but those other buyers are buying out the entire position of the fund, or really what's happening is they're finding out the LPs who want liquidity. They're figuring out which are the core assets that are still growing. And then they basically create a continuity vehicle with the high-quality assets, roll in the LPs who are still patient, buy out the LPs who are not patient.

51:40And now you've got a great high-quality portfolio you can run for another five years, whether that's maintained by the same managers or new managers. you're basically sitting on high quality assets that are hopefully heading towards an IPO, but you can extend the life of the vehicle three to five years and manage out the LPs who are patient and pay off the LPs who want liquidity. I think that's going to be a really big business that's going to start happening in the next couple of years. The other one that we are doing that I think is really probably on a lot of people's minds right now is buying secondary and strip sales to generate DPI.

52:18There's a ton of managers who are sitting on paper gains and performance. Maybe I don't always believe that they've got 5x there. That's probably based on that 2020-21 valuation, but they might have 2.5 to 3x of real value, but they have zero DPI or very small DPI. And so IPO activity and honestly, not that much M &A activity. I think you're going to see a lot of people doing deals to do strip sales to generate dpi and those fund managers want to be able to raise their next fund um so that's another area where we think we're seeing a lot more interest from managers to do secondary sales are we seeing funds that are shutting down looking for custodians to wind them down i know like two funds i was involved in as an lp that are not continuing on they're not doing the next fund and um you know i didn't ask them explicitly like are you going to manage this for the next you know it's your four of the fund who's going to manage it for the next 12 or 10 or whatever it is years at least right yeah so what happens to all these fund managers who are a lot of it depends uh depends on whether you know the lps are friendly or not depends on whether it's an audited fund or not uh depends on whether they have winners in that fund or not.

53:36But I think that half the audience is probably the default case, which is a lot of people jump into venture and don't continue. In fact, that's the majority case. And when these are larger funds, maybe there's some continuity there. They have management fees to live on. But for most smaller funds, you're not hosting for five years on the management fees of a five to$20 million fund, at least in most cases. so i think those will probably bifurcate into the folks who have winners and or the folks who are committed to a career adventure but for the majority of those folks who don't have winners or are not committed to a career yeah those those funds are probably going to be uh walking dead to some extent um depends on what kind of you know support is required from the companies to maintain them.

54:28The real question is from the investor's perspective, do they expect anything out of that? And are they expecting to get quarterly reports and who's watching the story? Have you had it happen, Jordan, to any of yours? Not yet. No, we have not. I haven't had it happen. I haven't had anyone signal that it's going to happen. But our first fund, the first investment we made from it was 2022, right, into a net new 2022 fund. So we've invested into 2022, 2023, some 2024 funds. So I really hope nobody is thinking about shutting down within their first or second year. That would be problematic. I really enjoyed the first year.

55:04I'm out. It's between year four to eight when people decide to check out. I mean, you're past the investment period and you're probably past when you've had sort of the front-loaded management fees. When you're done writing checks and when management fees start to ramp down, typically around year five six seven if you don't have winners a lot of people check out yeah it's a it's a paradoxical career because you don't know if you're good at it until year six or seven seven yeah right and so like how often is it like playing the yeah you can play basketball and we'll tell you when you get to year seven playing basketball or running marathons or being a chef, like your seventh year as a chef will know if you're any good at it.

55:52It's like, Hmm. Yeah. Well, it's interesting. I want to raise a fund every like three to four years. Right. You're going to check out if you haven't raised a fund in the last four or five years. That makes sense. And that's a really interesting point too, where it's like, okay, when we're, for example, going to re-underwrite a fund, right? And we're, let's say, for this current fund that we have right now. I'd anticipate half our managers are going to be re-ups from Fund 1. And what do we have to look at? Well, the investment we made in Fund 1 is not going to have a whole lot of performance. And to your points, it's not really like you can draw a whole lot of conclusions from it.

56:31You can look at, did they do what they said they were going to do? Did they improve their team? Did someone leave? Is there any drama? You can look at their older portfolios and say, okay, they seem to think this thesis was going to work. And by now, we actually see more of it working or less of it working. But if it's a new fund, and all you have to go on is one fund or even potentially two sometimes, that can be a little bit more difficult. What do you go off of in that case? What are some leading indicators that you look at that help you make that decision? So it can be a number of different things.

57:03And I think it can be case by case basis as well. Our thesis around venture is centered around the following, which is, Is this individual, is this fund manager, this firm going to see the best opportunities and the best founders? Are they going to be able to win investments into those founders and into those companies? And I think that's a really key element. And then how do we kind of prove that those two things are true and that they're able to pick the right ones from the bunch? And so in a lot of cases, from our perspective, we're never going to invest in a fund one where that person hasn't invested in a company before.

57:37And it's like a true first time venture capital investor. The three fun ones that we did in our first fund were all generally spin outs from institutional firms. And so, you know, there you at least know, okay, well, here are some of the companies they invested in prior. And so you can continue to follow that story. you know we'll do new references we'll talk to their founders that they've invested in you know from prior funds as well as the fund we've invested in trying to get to the answer of would you recommend this person to a founder friend of yours have they done the things they said they would get they were going to do right and maintain the type of reputation where they will continue to be able to win deals and continue to be able to support entrepreneurs it's a lot of qualitative work i would say and requires pretty significant resources to be able to get right and then we'll also talk to the rest of the community, right?

58:23We'll talk to other venture firms. So say, hey, you know, Andres and Horwitz, you know, what's your perspective? You've been working with this group here on two boards with them. You know, how have they delivered over the last couple of years? How has that reputation maybe changed, not changed? And so, you know, talking to those GPs as equally as important. And then we'll talk to other LPs too, right? Who are generally able to do similar things that we can from those references, from their analysis, and really benefit from aggregating the information that they've generated along with ours within that community to try and make that assessment.

58:56But beyond that, it's not like you can run some model and say, yes, this checks or no, this doesn't. Yeah, I think we do a fair number of small checks as LPs, primary LPs into funds. And I've been doing that for probably the last 10 years or so. So we've invested small tickets into about 40 or 50 fund managers. And when we were doing this at 500, we had started about 20 small funds within 500. Jordan's spot on. It's very difficult to do diligence in the first three, four years of a VC's career. But I think Jason mentioned this on a previous podcast, and it's sort of the same math that I look at, which is what's the progression from pre-seed or seed to series B?

59:39And there's several rounds in between there. and you're not looking at it on an exclusively quantitative basis. Everybody can get lucky and get one big winner here and there. But what you're looking at is a proportional progression of the portfolio where you're getting consistently, let's say, anywhere from 30 % to 50 % of your bets from pre-seed to seed, from seed to series A, from A to B. And probably somewhere around series B, you've got a company that's actually got revenue, got product market fit, and is progressing. And not necessarily that that's going to be a great investment, but if I'm looking at early stage managers, I want to find out what's their ability to sort of pick and or help companies from those early stages to some level of sustainable progress, which is usually, in my opinion, three funding rounds.

1:00:32But somewhere between pre-seed seed to series B is that progression. And if they can get a minimum of 10 to 15 % of the companies, regardless of the quantitative outcome and TVPI, that's interesting. Certainly, if they're getting 20%, you know, from C to B, that's a pretty good number. yeah that continuation strategy um and that data was something i was introduced to going out for my fourth fund i had never studied it uh and really focused on it but i did see that some of the larger lps did look at that and we had to uh you know have them not benchmark us versus seed funds i was like oh no no no we bring the inventory to seed funds so at seed funds our percentage looks really bad but then when you compare it to um other accelerators and pre-accelerators and pre-seed, it looks just fine.

1:01:21So each of those jumps, if you're doing your job correctly, you have a very low batting average if you're an accelerator. Because if you're an accelerator, you really are trying to work the power law. You really need to look for crazy ideas like Coinbase and Airbnb and Uber and Robinhood. You really need people who are trying to attack windmills. You need the crazy lunatic founders to bet on. And you can't just be betting on all SaaS, run-of-the-mill copycat products. You need outliers and you need to bet on crazy things. And those have just a very high attrition rate at the earliest stage, right?

1:01:5980%, 90 % going to zero when you're running an accelerator, pre-accelerator. But you're getting it at low prices. So I mean, I think they always have to balance that. There's something we used to look at, which I was calling value-weighted progression. and usually it was like, what's the round-to-round step up in value? What's the follow-up on or survival percentage? And what's the dilution? And if you multiply those numbers, theoretically, they should be better than one. In other words, if you're deploying a dollar, you should get better than a dollar's worth of value at the next stage. But it's also interesting math to look at for whether you should be doubling down or not.

1:02:34So we did that analysis at one point. Even though there's high attrition rate at the accelerator, the step up in round-to-round valuation is usually like 4x. Sometimes it's even more than that. So again, if you're getting in at between$1 to$2 million valuations and these companies are raising at a minimum of$8 to$10 million or even more, you have a really incredibly good step up in round-to-round value. And so if you get a significant percentage, let's say at least 30%, 40%, you're getting a number that's far greater than one. And conversely, it usually means that that's not such a great place to be making a follow-on bet.

1:03:12Because what we would typically see is that even with the attrition, because of a low valuation, we would get our best IRR check at pre-seed in the accelerator program. That's not always true in less competitive environments. In other places outside the US, that step up in round-to-round isn't as significant. So it might make sense to have more of a follow-on strategy in those less competitive markets. But if you're doing a good job as an accelerator manager or as a seed fund manager, you should be getting your best IR on your first check, in my opinion. Yeah. And just to build on that, it's the conversation I have with our RAAs, we call them researcher, people we hire out of school, analyst, somebody who's done 500 introductory meetings with the founder over Zoom, recorded them and written coverage of them.

1:04:01And then a thousand calls, you get to associate level. So these are... And people can do it in less than a year. They can get to 500, 1 ,000 calls in one year each step up. So we like them progressing quickly. And with that group, I will ask them to advocate. And they write their deal memos, they advocate for companies. And we have that record for all time, that they were saying, yes, we want to do this. And then I say, no, here's why. And then we have to live with that. But the framework I put into it when I'm asking them is, okay, we already own 7 % of this company for 125k call it a two million dollar valuation okay now they're going out of 10 in order for us to get another seven percent would be 700 000 so to dave's point do we need to get to 14 right now probably not what have they proven since they've graduated who knows but maybe we want to get to 10 ownership and then i asked them for that 300k would you rather do three more accelerator companies or two and a half, or would you like to do 12 more swings at bat at the 25k, two and a half percent?

1:05:11And inevitably they come back and they're like, I would like to do another 125k bet and I would rather do seven 25k bets, or I'll do two 125 bets and two 25k bets. I'd rather have more shots on goal for my performance. So this is a very interesting framing. that you do that. So many people have that follow-on framework. They don't think about, you have a limited amount of resources, you have a finite amount of bets that you want to make. Is the marginal amount of ownership you're going to get in this company worth it? Because you already have a bet on the table on this company. You really need to be buying 50 % more relative ownership.

1:05:50I would say arguably 100 % more relative ownership in order for that to really make sense. Because if the company is going to win, you've already got whatever ownership you've got. Are you sure you want to add a marginal amount of ownership in that versus betting on something else or betting on five other something else's? Yeah. And it really is a function of your deal flow. Maybe you don't have a better deal in your deal flow, or maybe you have too many good deals. I find myself having too many good deals wanting to come to our programs. And so I tend to lean towards that. But I did come up with a framework that has taken me about a year to come up with to train the team on what I think is a likely winner coming out of the sea shades and what i think is a definitive winner and now that i've codified that we have a much better framework so we do those two frameworks is it a likely or a definitive winner or would you rather make these more smaller bets in the programs and it's just changed everything memos into an ai i would love to see like three four years of that yeah okay great you're already thinking about it i mean this is the thing that's got to be gold four years later five well i've also tagged the data so we now you know every week hundreds and hundreds of applications come in and 70 meetings 70 calls 70 call notes you know and the stuff so yeah we are you know like the other day i was just like tell me how many marketplaces we didn't invest in and they were like 397 i was like email them all and ask for an update i love marketplaces I've made a lot of the money I've made in this life has come from Uber, Thumbtack, a lot of marketplaces in our portfolio that have done pretty well.

1:07:26So I'm like, get me the marketplaces from the database. We don't have any deals. Great. Let's go back to the deals in the database and being able to pick and my obsession, and I've said it before on this show, I have two things I'm super obsessed with right now. We have the deal flow. We have the decision-making. We don't need to compete to get in deals because it's seed and pre-seed. There's passing the hat most times. So really the doubling down strategy is really the thing I am most, and portfolio construction, which is the same thing, essentially. Our doubling down strategy is everything for us now, because we know we'll have in fund four 250 names.

1:08:03And we just need to add, we know there's going to be some breakouts. We just need to know which 10, which 5 % will break out and that's 12 13 companies out of 250 will break out which ones are those how do we know it's a breakout company or not that's the obsession i have right now you know i think there's a great article i don't know it's widely distributed but clint corver at ulu ventures uh wrote a pretty interesting analysis on follow-on strategy I think it was probably written about five or six years ago. And, you know, really somewhat, you know, contrarian. I think a lot of LPs, particularly institutional LPs, look to see, you know, conviction, which I think probably induces more follow-on behavior than the market should really be exhibiting.

1:08:57You know, I actually think the default case should be you should not follow on in most scenarios. You're better off making a diversified bet on another company. And it's only in the very clear cases of strong growth and significant marginal ownership that that follow-on bet really makes sense. Unless you're doing it out of a separate pocket or separate fund. I think from the LP perspective, they have exposure to 20 to 25 managers, and each of those have 20 to 25 companies. So they have 500 underlying companies. So they feel like they're capturing the power laws, but they want that alpha. They want the next Airbnb, you put in 25 % of your capital into that.

1:09:36They want that high outperformance. So there is some rationale there. But if that follow on bet is based on... It might be a good rationale for the LP, not for the emerging manager. For the GP, it's similar to a VC investing into a company. It ends up being an N equals one. And if you win, you win marginally. It doesn't really change your life. But if you lose, you don't do another fund. So there is somewhat of a mismatch there. I think from the LP side too, it's very funny. I've seen people who have shown me presentations that have said, if I had just leaned in more to this company, which is what we now do, look at the returns I would have made.

1:10:19And I have seen people say, if I hadn't followed on as much, which we don't do anymore, look at the returns I would have made. You can be successful doing it either way. I think some of the better returns we've seen have been from doubling down, tripling down. If you get it right, I think it works really well. And if you're able to leverage the kind of asymmetric informational advantage you may have, it can work really, really well. I'll tell you another concern is, you know, especially if you're investing across funds or if you're leading multiple rounds in a row, you know, are you propping this company up?

1:10:51Are you throwing good money after bad? And understanding that dynamic, too, I think is something that's important from the LP side. Yeah. If I could go back, I probably made 10 bets in each of the funds, first fund, second fund, third fund, maybe 20, where I wouldn't say they were sympathy bets, but they were founders who really resonated with me as a founder and who convinced me, yeah, they were going to figure it out. and I placed the bet, but maybe those bets would have been better into another new company. And we've now figured out a way to communicate that to folks, that we are not the permanent source of capital for our companies and that we don't invest in bridge rounds.

1:11:42We invest in companies once or twice and get to 7 % to 15 % ownership. and then we deploy capital into new companies. And once we explained that to folks, they were cool with it. They still might ask us, but I think a lot of GPs get caught up in loyalty to founders, which I understand. And I've been super loyal to founders and I wanna give them that support. But you have to have a portfolio strategy. And now we just say, hey, the fund you're in is fully deployed. That's it. and you wouldn't pass the rigor of the new fund because it's not growing right now. So we can't bridge you. That fund's closed.

1:12:22The new fund's open. You'd have to have 3X growth to compete for those new fund dollars. And when you do, we're happy to have that conversation. But the company's sideways. You got to go find money in the market. And I think that discipline is really important. It's really important. And you only get to that level of discipline, I feel, when you get to your third, fourth, fifth fund and you have to face the scrutiny of LPs or like, tell me about these re-ups. Tell me, somebody like Jordan, hey, I see you did these bets. What was your thinking? And I got to pull it up and go to the deal memo, go to the Slack conversation.

1:12:59Okay, yeah, I made a mistake. That was a poor bet. I put bad money. I put good money after bad. I made a bad bet on a startup. Okay, we're all adults, but then that second or third bet, that's where you really have to start questioning do you have a good portfolio strategy? I don't think I had a great portfolio strategy in the first couple of funds. I think I had the standard one, which was bet on 100 companies, hope for the best. By the way, Jason, you hit on something I think is interesting, which is the growth mindset, ability to get better and to learn and to evolve your strategy. When we talk about going back to how do we look at a fund, evaluate a fund one or a fund two when they're back in market, That is a part of it, right?

1:13:43Hey, I want to hear about the bad investments you've made and what did you learn from them? I want to hear about what you would do differently in your next fund and continue to see that growth. And so I think that's another element too. I don't think anyone would be surprised to hear me say that there is sometimes a little bit of ego in venture capital. And so, you know, to that extent, you know, when I know, right, crazy. And when you can see a little bit more sort of humility and growth and ownership and like, you know, I can always be better and I can always get better. I think that is also something that we find compelling.

1:14:16Now on to the lightning round of top three investments from each guest. Dave, go ahead. Well, I guess, you know, most of the investments we do are at the fund level and private. so I can't really talk about which deals we've done that are great there. I can talk about the direct secondary deals we've done. So I guess three of those, Mercury, which a lot of people probably know, is startup banking and APIs for companies. And credit to Zach Coelius. I'm an LP in Zach's fund. Zach is really amazing. I've tried to hire him at least twice in his career, my career. But he's running a great fund and Mercury was one of his winners and he helped us get into a private secondary in the company that was great and we'd love to own more.

1:15:11So that one's doing great. Also great as a customer if you're a startup looking for banking services. Mercury has supported my podcast over the years. Great company. Yeah. Really supportive of founders. another one that we're investing in is a company out of germany and austria austria called gropius actually working with them on changing the name to greener.com but they do factory automation and robotics for building prefab multi-family housing so condos and apartments you can kind of think about it as like a tesla factory for building condos a pretty amazing company the founders have both been involved in other public tech companies.

1:15:52One of the founders was previously involved in delivery hero. The other one led engineering at Zalando. It's about 400 people. Half of them are software engineers, and they basically do programming on these robotic arms to build, you know, prefab housing, basically walls and siding very quickly. And their customer isn't the end owner or renter, it's the real estate developer. And so they put together those walls and sidings, deliver them to the construction site, and then the real estate developer builds those houses a lot faster because they can just assemble them fairly quickly. And I think this is an interesting theme that I think we'll see in a lot of physical manufacturing companies is automation and robotics, sort of improving the economics and productivity of physical manufacturing.

1:16:44In the same way, everybody's going gonzo about AI making software companies better and more productive. I think robotics automation is going to make a lot of physical bits companies more productive. And then last one I'll highlight, we've been doing a fair number of secondaries in Latin America. For folks who aren't aware of it, Brazil and Mexico are really big drivers for the Latin American market, but it's a pretty large overall market that's larger than California GDP and half the size of China GDP. A company we invested there is called RicargaPay. That's out of Brazil. And basically, I don't know if many people know about this, but about two years ago, Brazil adopted a payment system.

1:17:30It's really driven by the central banks and the government over there called PIX. It's highlighted right there, P-I-X. in less than two years about 80 of the population is now using it broadly it's kind of amazing how quickly the adoption has happened um so ricargo pay is basically a payments platform kind of like a super app uh similar to maybe we pay in china that does a lot of things or uh like grab in singapore um and the i guess i want to say dirty little secret but not so dirty latin american companies are very reasonably priced. There's just not a lot of VC capital in Latin America, at least not on the scale that you see in the US or even maybe in Europe or India.

1:18:17And so valuations are quite reasonable. I think SoftBank had a big portfolio that was investing in Latin America many years back. It was about a$5 billion portfolio. For whatever reason, I won't get into SoftBank changed their mind, pulled out of that. And the guy who was running SoftBank's portfolio in Latin America, Marcel Clare, raised a fund called Bicycle Capital that was$500 million and is still investing in Latin America. So I think there's really great opportunities, not just this company. We've made three or four investments down there. Brazil and Mexico in particular are really taking off, but the overall market for Spanish-speaking Latin America and Brazil, which speaks Portuguese, is tremendous.

1:19:05Amazing. I'll go super fast. I have a little bit of a theme today about websites and people building websites. So this first one is called Motive. This company reached out to us. It was like one of these seemingly boring businesses. It was a website builder, but this was a website builder for people who own dealerships. And it turns out, you know, these dealerships need websites. They're incredibly complex to build. And a lot of commerce goes through them and the entire world is moving to buying online. and we invested in this company that helps these dealerships build websites. And man, is it doing really well.

1:19:48So there's Squarespace. We love Squarespace for general and building anything. But there are some websites that are super complex, long tail of websites. And we've found a number of companies that are working on that. TestRigger went through, found a university, and our accelerator. We made two bets on them, I believe. And it's a generative AI-based test automation solution. People should be writing tests when they write code. They don't. And they're just taking that little narrow spot and trying to solve this problem. And then finally, Krepling is building a drag and drop WYSIWYG style editor, AI powered editor for building modern e-commerce websites.

1:20:27And so you can go into this, as you can see here, and build workflows about registered users coming and then have them send an email, then offer a discount. So it's kind of pulling together offers and publishing and app building. Really amazing how this company has done. We made a small investment and then we watched them raise their prices. One of the great pieces of advice we generally have for companies is raise your prices. Same number of customers, triple your price, lose 10 % of your customers, net, net. You're now at 270. Let's say you were at$100 and you had 10 customers paying$10 each.

1:21:06raise it to$30, you'll lose one. That's just fine. You're going to still do okay. And you'll lose your worst customer too. And you tend to lose the worst one. But I really like your sustainable living company here. We had an investment in a company that was doing modular housing and it was incredibly hard. And it seems like almost everybody who's gone up this hill has failed. But I do think somebody will figure it out and it's going to be a great investment. So I really would love to meet them at some point. Well done. I'll connect you. They've got a pipeline of business in Germany that's huge, and we're trying to bring them to the US.

1:21:43Really, really hard business, and developers are really hard customers. That's one of the things we learned is that developers, selling into developers is really hard because they want to pay the lowest price possible and then sell at the highest margin. So their incentive is, you know, super, you know, to deliver the cheapest product and have the highest margin. What's the price per door, but they don't realize is like, running of an apartment is the most the cost of running the apartment is equally important for the person who builds or owns the thing. So your HVAC, your efficiency and energy, resistance to flooding and fire, which are the two biggest disasters in apartments and the biggest cost centers is floods and fires, even if they're contained.

1:22:28And so you should be incented to use better materials, better HVAC, better insulation. But the construction people are like, oh, screw that. Just give us cheaper, cheaper, cheaper, cheaper. We want to buy this for$50 a square foot and sell it for 400 a square foot. you know we want to open each door for the lowest price possible it's like well the ongoing uh you know maintenance of these things also should come into play well you hit on the part two of their business because they build digital building sensors into all those materials so once they deliver them there's actually a building operating system that the developers can run to measure all that as well which is super important yeah to know that this unit's got a flood or this one's on fire pretty important information that they generally don't have.

1:23:12Jordan, real quick, last three fund investments. Yeah, go super quick. So the first two investments out of our recent fund, the one we literally just launched like five minutes ago, are Andres and Horowitz, who was a fund one investment that we made as well. Long relationship there, love what they do. I think they're absolutely fantastic. And then that sort of upper echelon of top tier firms. I'll say founders fund kind of by default in the sense that we invested in their prior fund, which they ended up cutting in half given the macro. And I applaud them for it. They're one of very few managers I know who has sort of taken money out of their own pocket in a sense to become what they view as in line with the macro.

1:23:56And so some of that initial exposure got pushed to their next fund, which we are investors in out of our fund that we just launched as well. So those are the first two. And then the last investment we made out of our fund one, which was last fall, I want to say was seven, seven, six. So, you know, Alexis Ohanian's fund, a lot of respect for, you know, what he's built there. And, you know, obviously, that goes back to the first thing we talked about as he was with Gary at that initialized. And he was the co-founder of Reddit, or the record. That's also, yeah, you're right. I know. I was getting there.

1:24:33Lest anybody forget their tweet at a firm that he co-founded.

1:24:42You know why it's so contentious, right? Because there's so little at stake. It's just a tweet, folks. People are starting to spill tea and shade over a tweet. I mean, how do they leave him out? He's a co-founder. Aye, aye, aye. He's incredible. Going back to the comment I made earlier about like being humble and gracious um i would put him in that camp for sure uh he is just such a really really good human being and so those are those are our most recent three amazing awesome well this has been an amazing episode david thanks for hosting again well done am i going to see you at the uh liquidity summit david are you gonna make it you will see me um and i'm excited about it i saw some of the guests coming they're pretty impressive so i'm excited pretty impressive i need more LPs to come.

1:25:33It's going to be June 2nd, 3rd, 4th, and 5th, but the main days are 2nd and 3rd. I'm sorry, the 3rd and 4th are like the content and activities days. The 2nd is just a welcome dinner and poker. And then the Wednesday is going to be like a closing brunch. But I'm kind of making it, it used to be called Angel Summit. Now I just called it liquidity because it stopped being about angels. It started being about the LPs and the GPs. And we had, I just emailed all the GPs in our world and I think 70 of them signed up and so now I'm in the process of inviting the LPs what do you want you want it you want foundations you want endowments I think a couple of each would be great and then I you know I'm trying to figure out what to do with this event I want to do it twice a year I want it to be super constructive so one day of full content poker every night second day some content and then uh the afternoon events but I'm wondering if I should do what iConnections does and have speed dating but I kind of find speed dating I don't know how do you feel about it Jordan if I was like hey here's five fund managers do you want to sit with them or would you rather just meet them casually I have always found that at those types of events when you try and do speed dating you suffer from massive adverse selection from my perspective I'd so much rather just identify who it is ahead of time and try and find a way to connect with them yeah um yeah i did like i connections i went to i connections twice and it was nice to set up meetings they weren't all they were double opt-in what did you say uh dave i think you should facilitate that process before they go and then have have the meetings that everybody opted into double opted into there but like usually what i would say is the speed dating is a mismatch for like 80 of the dates but there's no reason why you couldn't figure that out ahead of time in my opinion you don't need to have the gps have tables and let the g the lps come to meet them if they want to one morning yeah i think if you've got like the gps to give you like a one pager on their fund maybe a 30 60 second video if they want or or a short deck oh that's a good way to do it send it ahead of time oh yeah let me here's a presentation on my fund in the deal memo and then you could if you want to meet you meet that's a good way to do it yeah so i don't yeah As an LP, if I got a list of one-pagers on all these firms, I think I would start by prioritizing the ones that I'm familiar with and say, okay, this is actually someone I've wanted to talk to or someone I haven't talked to in a while or whatever.

1:28:05And I'd go through the rest and say, this is actually really interesting or really compelling or whatever. And I love that idea, actually. That would be, from my perspective, fantastic. What do you think of the video? You like the idea of a video or you just want to do a memo? I think videos are always helpful. I would watch it if I liked the memo. I would not watch it unless I like Genome. All right, Dave. Do I get to come now? Sure. I mean, you're here. So, of course. Where is it happening? I do it in Napa. This is the sixth year I've done it. It might be the seventh. I just did it because my book, Angel, came out.

1:28:39And a lot of angel investors were like, hey, I want to hang out. And so we would just do this angel summit. And it was originally, I thought, maybe we'd get 50 people together. And then it's always been 125, which is the maximum most restaurants in Napa will take. So I've tried to keep it to 125. I got 70 GPs already. So I'm going to cut off GPs coming. And then I'm just going to have the other 50 slots be for LPs and founders can't come to it. And then service providers, we let them come if they buy dinner. So if they do a 25 or 50K sponsorship, we give them one or two tickets and they just pay for the dinner, whatever.

1:29:14And so it defers a little bit of our cost if they want to do that. So typically banks or law firms or accounting firms or whatever will, you know, they'll want to buy lunch for everybody. And so it's quite nice. But I'm trying to figure out a way to do it that doesn't become overbearing because I don't want it to become like a bizarre and haggling and hard selling. So I like the idea of like more activities. Hey, we go on a wine tasting. We go to cooking class. You meet some people. You meet some people at poker, you know, or some board games will be set up. So you kind of more casually meet people is my goal.

1:29:47You know, it's interesting. Mark Schuster did this for a while and it became so successfully stopped doing it. He would publish the list of all the LPs and GPs that are going and people self-aggregate. That could be another potential solution. Yeah. I will say I have found the less you can make it like a conference, the better in my perspective. The more you can just have people organically converse and get to know one another, I think it's far more valuable. All right. Got it. All right, Jordan. You're in. you're a fund of fun. So you should come anyway. Yeah. It'd be great to have you. We're going to do a fund of fun panel.

1:30:23So you should be on that panel, like not panels. We're going to have three fund of funds, give like a five to 10 minute, like, Hey, here's how we think about the world and then have a round table discussion with the audience. So I'm trying to have it be just five minutes, 10 minutes of like, here's what I think is happening in the world. So it's like low pressure presentation. Like it could be one chart. Here's what we believe. And then the next person, here's what I believe next person. here's what I believe right now. And then group discussion and then audience microphones passing. It really worked out really well in the last time.

1:30:53All right. Close this up, David. We went long. Well, it's been another great episode of the liquidity podcast for Dave McClure, Jordan Stein, Jason Calacanis. This is your host, David Weisberg. Thanks for listening.