Misaligned Incentives Between GPs and Founders with Altimeter's Jamin Ball | E2045

23:51Okay. Yeah. That explains the capital wave that we're describing. Now let's turn to the founders. One thing that you said was the old model kept venture capitalists and the founders they backed in line or aligned because they were together for 10 years. Now with a faster fundraising cadence and a faster deployment cadence and more of an index approach, as you mentioned earlier, founders can get a big check and then be effectively left in the lurch if they aren't one of those absolute outlier companies. Tell us about that dynamic. And then if you could jam in, how often do you hear from founders who have been essentially left by the side of the road by their prior backers?

24:29Yeah. I mean, I think, I think that kind of happens all the time. And again, that's probably like a trend that was just made stronger in the 2021 period. But it is, an issue, right? Like there was kind of the, you know, the cottage industry days of venture capital where you were a true partner through thick and through thin. And you had eight boards that you were on and you spent a very real amount of time with every company that you were on the board of. And that was a real responsibility to work with companies at a board level. You know, now as funds gotten bigger, there's just a reality that you just have to make a certain number of investments.

25:00Like the only way to deploy that dollars, again, I think unless you're deploying it in this really concentrated growth strategy, you just have to make a lot of investments and there's just like limits of time, right? If you're sitting on 30 boards, there's just no way you can spend a lot of time with every individual company. The model becomes more of find company, invest in company, then find the next company. And it's more about deploying the net new dollar versus optimizing the existing dollars that have already been spent or invested. Spent sounds too transactional. But I think that's just a reality, right?

25:30Where at the end of the day, again, from a purely rational standpoint, if there's going to be a few things that really matter, you should spend all your time on those few things. But that leads to suboptimal outcomes for founders, because at the end of the day, like if your company is crushing it, probably don't, I mean, not that you ever need your venture capitalist, but like, you know, you need them less. You probably have less questions for them. You probably have less challenges that you have to deal with, less one-off things that come up and you're kind of on, you know, you're not on cruise control.

25:56You're doing a ton of work, but like, you're just, you're operating well, absent your board. Right. You don't need training wheels if you're already going really fast because you've got a good momentum. Yeah. When companies are struggling, it's when you, again, air quotes, need, right? More of that board. It's how do we handle the future of this company? Should we sell it? How should we go about selling it? Should we shut it down? What are the implications? You know, there's just a lot of other questions that I think the benefit of an investor board member can be quite helpful. But, you know, again, that's probably the time you're less likely to get that attention and time.

26:27Just given the nature of you're on so many boards and there's only so much you can individually do. So I want to ask about like what this means for founders today who are going out and approaching the market. Now, fundraising is always difficult unless you're incredibly lucky and doing incredibly well, at which point none of this advice applies to you anyway. So put those aside. But if you're a founder out there and you're looking to raise capital, let's say seed through series B, and you're looking at funds and firms that are a variety of sizes. What advice do you give to founders in terms of sizing up what type of firm is the right fit for their company and their approach?

27:06Yeah. Look, I would say, I don't want the takeaway to be like big fund equals bat, right? It's just more about like, what are you getting from your partner? It's not just the firm, it's the partner who's at that firm. Like how committed to your success are they? And there's lots of different ways to answer that question. There are a few important things to also consider, right? Again, let's think back to one of the incentives of large funds is to deploy them so you could raise the next big fund, right? You kind of become a machine. And to go back to why that matters, if you raise another billion dollar fund while you start another$20 million a year, 10 year timer, you get a couple of those going and suddenly you're just flying on your jet and chilling and it doesn't really matter what the stock market's doing.

27:45Back to you. Sure. Yeah. I mean, these funds stack fees, right? When you're, when you raise fund three, you are still collecting fees on fund one and fund two. Those don't stop. And so the more you raise, right, the more fees you generate. So what does that lead to? It can lead to situations where your primary KPI is deployment. Hey, I don't want to deploy 50. I want to deploy 100. You've seen round sizes balloon. Are companies growing faster than they ever had? Yes. Are they growing headcount faster than they ever had? Yes. Could they then absorb more capital than they ever have? Yes. But I would say the magnitude of which rounds have increased is far outpaced the, I'd say maybe the trajectory of kind of company growth.

28:26And so you might set out raising a$25 million Series B, but you'll get$50 million Series B offers. Now, why is that? Is it actually good for your company? You might say, wow, great. It's more money. Yes. At a higher valuation. Yes. This firm has the deepest conviction in me. But the reality is, is their incentives might be just to deploy more money. And it's not necessarily that they have all that more conviction in you. it's hey in a power law outcome doesn't matter if i pay 100 or 200 because if this is a 20 billion dollar company that's a power law outcome i just need to deploy more money right but you know again and what lesson have i learned there's gosh there's a lot to unpack coming up here coming out of 21 like over capitalizing and over valuing a business really can create risk um what are the benefits of it it might be less for the founder because people might think oh my gosh more capital more capability, more flexibility, more time, but higher valuations that come with larger checks come with their own expectations and you can end up essentially stuck.

29:21And my, my rejamming is that some companies that may have done better essentially were overcapitalized to the point to which they kind of like kind of choked on their own spit. I'll give you a couple examples, right? Which is generally what I like companies to do is raise a round, hit milestones, raise the next round, hit milestones, raise the next round. Oh yeah. By raising a lot of money at a much higher valuation, what you end up creating is this structure of raise a round, hit four milestones, raise the next round, right? Because ultimately you may be able to raise off of hype and you may, the good times may keep rolling, but at some point it might shift.

29:55And then you'll need underlying business momentum and fundamentals to justify an up round. Startups are hard, right? They're fraught with risk. They're fraught with challenges. And stacking four milestones in a row is hard. You might hit a road bump at milestone two or three. It might take you longer. It oftentimes does. But when that happens, if kind of you're staring down the barrel of like a really high valuation, you know, you're not worth today, just kind of creates existential questions for the execs, for the employees. Hey, are we ever going to grow into this valuation? Oh my gosh, like we're not a rocket ship anymore.

30:24What's going? I got to get off. And it just kind of, when you raise these big rounds at big prices over and over and over again, it kind of creates, I don't want to call it an illusion, but it creates an illusion that, hey, this is a just, it's going to the moon. and companies move from hiring missionaries in the early days, people who deeply believe in what the company is doing, the problem they're solving, the product to mercenaries. Hey, this company is a rocket ship and I'm going to make money on my equity. The challenge is you hire a lot of people who that's why they join. When you then hit a road bump or two or three, and you will, then people start to question, oh, wait a second.

30:56We were raising at 3x markups every six months, every year. Now all of a sudden we're not like, maybe I was wrong, right? I didn't join the company with deep conviction, which means I'm going to leave the company with loose conviction. And then you hired all these people, you trained them up, people leaving, those attitudes are infectious. There's inertia to it. Jammin leaves. And I talked to Alex. Oh, hey, Alex. I was reading Jammin's Cloud of Judgment and he says software companies are only worth eight times revenue. If we apply that multiple to our business, we're at 80 % discount to our private.

31:25We're never making money. We got to go. It becomes infectious. And you hire all these people for the wrong reason who then leave. And it's just, it creates a lot of turmoil that you have to come out of. All right, everybody, welcome back to the program. Stephen Estes is with us again. He's a principal at CLA, a professional services provider. They specialize in CPA, tax consulting, and wealth advisory. His areas of expertise lie in VC-backed startups, VC funds, high-growth startups with complex tax issues in multistate and international filings. Welcome back to the program, Stephen. Hey, thanks, Jason.

31:57Appreciate it. The last couple of years, it's been a little bit rocky in startup land after the bubble burst, post-zerk. Tell me, what are founders sweating right now? What's keeping them up at night? I'll take the low-hanging fruit here and say funding. Before the pandemic, VCs were just printing money. And the last four years after the pandemic have been a bit of a roller coaster in terms of capital availability. And I think things tightened up right after. And then in 2022, 23, capital seemed to open back up. Now we've got inflation and interest rates are higher. So we're kind of back in a position where money's tightened up because investors can get a good return someplace else.

32:30Gone are the days when an Ivy League degree and an idea on the back of a bar napkin would get 10 VCs lined up to invest in a seed round. They're being asked to do more with less and anything they can do to defer the need to raise again for as long as possible because the valuations out there just aren't what they used to be. All right. You need a trusted advisor. Tax is accounting. You don't want to play games with this stuff. Get it right. Get a great partner like CLA. go to claconnect.com slash tech and let them know your boy Jake Al sent you once again, claconnect.com slash tech. You know, and this is always a conversation I have with everyone, which is when you raise a round of venture capital, you're implicitly committing to something.

33:07And what I mean by that is generally like raising rounds and especially raising big rounds, it closes a path for an exit, right? Let's say you raise a hundred million dollars as a series A company. The way cap tables work is venture dollars invested going to primary shares, which means primary shareholders get paid back first on their investment prior to everyone else in the cap table. That's founder shares, that's common shares, that's everything. So if you raise$100 million pre-product market fit, that means if the company sells for less than$100 million, nothing will flow through to anyone who's not a preferred shareholder, which means you have closed that exit path.

33:48The counter is if you're a founder, you might own 30%, 40 % of your business at series A. If you sell that for a hundred million dollars, that could be a$40 million payday. That's life-changing. That's massive. But that path is no longer on the table. If you raise a hundred million dollars, you are implicitly committing to the next big outcome. And one of my big challenges with the big fund dynamic is big funds are driven by power laws. What matters to my fund, what matters to all funds are, are you a home run or are you a zero? That's really all that matters. And even the in-betweens don't really matter.

34:19Here's the irony of venture funds. If I run a fund that gets to a 3X return, if I have an individual investment in the fund that returns a 3X, that individual investment is actually irrelevant because I guarantee you, if that 3X investment was a zero, the fund would still be a 3X because the fund got to a 3X because of the 30X deal, the 40X deal. And so the middle outcomes, again, I don't want to say they're irrelevant. They can all be accretive, but they don't matter in my ultimate goal of kind of delivering a top quartile fund. But that's important to call out because the middle ground outcomes can be especially meaningful to founders and employees.

34:53Yes. But this is just this world where these big rounds, again, it is shutting a lot of those middle ground doors. And I don't think oftentimes founders realize that, hey, we have just implicitly shut that exit path door. And now we're playing the same game as the venture capitalists is boom or bust. The difference is as a founder, I have one bet I get to make. It's my company. You know, venture capitalists get to build a portfolio. And they're getting the 2 % the entire time. But I want to take what you just said and apply it to a theme we've been talking about on the show a lot, which is the startup M &A dearth or just the lack of access that we've been seeing.

35:27And you mentioned IPOs being delayed and that's a known phenomena, but there's been a lot of commentary in the, in the venture world, startup world about kind of who's to blame for the lack of M &A essentially. And I know a lot of people have perspectives on Lena Kahn and so forth, but it seems also that venture is partially to blame because if they are putting too much money into these companies too early, closing off doors, well, there go the singles and doubles, to use the classic baseball analogy, that some people in the venture world really seem to care about or covet. So, you know, as part of the lack of exits, just venture capitalists overcapitalizing early stage companies.

36:04It can be. And it has two impacts here. First, let's talk IPO markets. Second, let's talk M &A markets. Everyone likes to say, are M &A markets open or are they closed? I kind of take a different perspective. They're always open. The market clearing price just varies. And you're either willing to take the market clearing price or you're not. One challenge is all of these companies are, again, of all the unicorns, there's maybe a 1 ,300, I read some article, 1 ,300 private unicorns. Yeah. Yeah. I'd probably wager 5 % or less of those unicorns will ever actually exit at a price greater than what they raised in a Zerp round.

36:38It's a really small number that will. What's one reason people think the IPO markets are closed? You raise around at$5,$6 billion, but if you were public today, you were$2 billion, you're like, I don't want to do that. Maybe your board doesn't want you to do it. Your board doesn't want to take that mark. Your investors don't want to take that hit. Hey, just keep growing. Eventually you'll be worth more. You'll grow into it. But if your last round was a billion dollars, maybe you go public at$2 billion. You could double your last round price. There's no employee hit. There's no morale issues. You just doubled your valuation in an IPO.

37:10But if you raise it$6 billion, you don't want to go public at$2 billion. That's a down round. Your investors might not want that. It looks bad for everybody involved. It looks bad. There's momentum issues. And so I think one of the reasons you don't see a lot of these IPOs is that there is just a market clearing price people don't want to accept because you can raise it 30 times revenue in the private markets and five times in the public markets. And there's just a big valuation gap there. And that'll change, right? I think today the public markets are placing a premium on platforms, right? It's, hey, have you proven you have hit escape velocity and you have staying power versus are you a point solution that might have a zero terminal value five to 10 years from now because you're disrupted?

37:51So you have large companies that are successful companies, like a Confluent or a Braze or Rubrik, or, you know, I'm just trying to think of other IPOs, like, you know, solid, very good companies that just don't trade at big multiples. Right. And so for every, I mean, I, you know, off the top of my head, I think they all trade at less than 10 times revenue. I might be wrong, but I think they're all less than 10 times. That feels right. Especially Braze, which was a 2022 IPO. It was very, that was very recently. Yeah. Yeah. And so it's like, you have, you have really good companies that are growing well at scale, but they're not a billion dollars of revenue plus.

38:23And I think there's just this question and the public markets today are placing a premium on large companies. What are startups? They're not going to be a billion dollars of revenue. They might have 200. So the market clearing price today for a subscale software company, it's just a huge delta between what you were able to raise that in the private markets. And so that's a really tough pill to swallow that no one wants to. But how have we ended up still here? Because I feel like everything you're describing right now is not newly true. This has been a multi-year situation in which we've been staring at the same gap between public multiples and private valuation.

39:02And I'm just sitting around going, surely eventually people are going to have to bite the bullet, swallow the poison, take the market clearing price and get out. And it turns out the answer is no, not really, because we're just sitting here so jim when does it does there come a point when things break and then the logjam does release or do we just keep adding tension to the spring until it explodes i mean i don't know i i think there was probably a normal amount of like startup liquidity that you know if you were to graph it over time you know it was probably going up um but the reality is, is that it wasn't going to exponentially change.

39:41And so we started funding companies as if the exit environment would fundamentally change. And I think the reality is, is we're just reverting to the mean. And I don't think the log jam ever breaks. I think, look, like rates are going down, markets will come back. Maybe there's a new regime on the government and M &A picks back up, but like, we're not exponentially picking up. And so I just think the reality is, is there were a lot of companies that were overfunded that shouldn't have been. And there was a lot of money that was lit on fire that we're not going to see back. Right. But, but go back to our point about how large funds with brand names can absorb a lot of capital and are staying large.

40:12Yeah. And the fact that we are overcapitalizing startups and ending up with valuations that are often unpalatable to public markets. Yeah. To me, that just seems like a recipe for more of the same. And so I wonder why isn't there a movement? And I know the answer to this, but this is rhetorical. Why isn't there a movement among VCs to build smaller funds that can do better, not only for themselves and an IOR basis, but also to help founders capitalize correctly and have exits. And the answer is essentially fees to your original point, but it drives me nuts. It's incentives. And I mean, just think about it.

40:47Like, yes, let's say you had a big multi-billion dollar fund. You could get smaller, but you're gonna have to lay off a bunch of people. You're gonna have to deal with reputational damage. Like it's the same reason it's hard for companies to take down. I mean, this is so funny. I was just about to say this. Venture capitalists are always like, oh, take the down round, take your medicine. Like, it's not a big deal. And they're like, but it is a big deal. It's the same thing for venture funds. Like there's just, you know, imagine the headline, like, oh, you know, this fund raised at like 20 % of the last fund size, like the appearances you're losing momentum, the appearances you couldn't raise, like, even if you chose that, there's just an appearance of it.

41:21And then the reality is, is, you know, if you raise a fund that's, you know, a fifth the size, like, you don't need the huge team that you had to deploy the fund 5x is big and so you're gonna have to lay people off and that's hard and so like there's just inertia and when the inertia allows it to continue if you're able to raise it you know you i think bill said this it's like it's hard to point to like one individual constituent to say like this person was at fault was it lps was it founders was a gps was someone else was it the fed like it's hard to point to one individual constituent yeah we all just kind of got here right and now that you're here then the question is what do you want to do right do you want to take your medicine and it's painful like or do you just kind of want to stay the course so essentially the same problem that we have with these uh unicorns that are stuck somewhere at a really let's say a fraction of their theoretical worth and venture capital firms that have become very large and are used to eating well off of a creative AUM they both are not really incentivized to change the status quo so we're going to end up with oh okay that's but yeah i mean it's even different right it's like there's not a doubt i mean the downside for the companies is like you're in a zombie march right and you're like slowly going to zero but you have a lot of runway really bad like that's bad no no no this is what i'm saying that's bad but like there that doesn't happen that doesn't exist for venture funds oh oh i see it's more painful for the founders more painful yeah and so like there's actually you know like if you you know this term zombie gets used a lot like if you're like a zombie growth stage software company like you're not able to raise more money you just can't no one wants to or they will but at a massive discount or with tons of structure as we've kind of said earlier there's still a lot of demand for large venture funds and so like there isn't a zombie venture fund no one's going out there and saying we're going to back the companies that are only growing at 17 a year yeah like there's just like everyone still wants you know again i say this holistically it's it's not this black and white but like there's still a lot of demand for very large funds, you know, and because it is this power law, because companies are staying private longer, because there is more value to be captured in the private markets than there ever has been before.

43:32Now, individual firms might take different approaches to that, which either put them in line or out of line with founders incentives, or with LPs desires for returns. But right, the LP environment is also changing, you have a whole new class of LPs that have different return expectations that have a different cost of capital and so like the you know the checkers game has become chess right in in some ways but yeah i don't know it's it's hard to know like what's the forcing function to this changing i don't know i have one i have one idea and i know that if you are a partner in a venture capital fund you are expected to put some of your own capital into that vehicle skin in the game again aligned incentives if your own money is in the fund you're going to be more careful with it So I'm curious if the percentage of AUM on a perf, but just percentage of new fund that partners put in has changed.

44:24And if so, has it gone down? And if so, by how much? Yeah, I honestly don't have tons of insight into this. Maybe just for the audience, what Alex is talking about, it's what's called the GP commit, which typically says, if you raise a fund of size X, the GPs, so the investors in the fund will contribute 1 % to 2 % of that. And that's, I think, historically what it's been. It's about 1 % to 2%. So let's go back to that $100 million fund. The investors at the fund of that$100 million are going to contribute 1 % to million. And oftentimes that is split proportionally amongst the different kind of seniorities of the venture fund.

44:59But again, let's go back, right? That used to be very significant. Now you have a lot of folks who have made a lot of money. And so while yes, the dollar value of that GP commit has gone up, so has the net worth of the people putting it in, right? And so it's like on a relative basis, it might actually be a smaller percentage of their net worth, right? Because again, historically, like there are financial products, it's like cap call lines, right? Like you go to, you know, a bank and you have to take out a line of credit to fund your cap call. Like that's, you know, like that's very committed.

45:29Like you're literally taking out a loan to fund your capital commitment to the fund, right? Like you better hope those investments work out because now you have a loan. Whereas now it's just a little different. I think everyone is, the industry has gotten bigger, the industry has gotten richer. And I don't know if the percents have changed. Again, I don't have tons of insight, but they've certainly lowered as a percentage of net worth. And so. Well, then I think to solve, then we just need to tune that up because the more of a fund that a VC owns, the more likely I think they're going to be willing to put time in to save companies that might not be that grand slam that you're looking for, but might be a triple.

46:06And you certainly do. You certainly have funds that have a larger portion of the GP commit. But what I go back to is like, who's going to mandate that? Obviously the LPs want that. But again, let's think about a rational actor. Why not put$0 at work and guarantee a ton of money? like pure economic capitalist animal, right? That is probably the preferred path, but who's going to mandate that, you know, back to this supply demand, there's such a wall of demand for the venture asset class. You as an LP might say, Hey, you know what? Jam in 5%. GP commit needs to be 5%. I'm not investing unless you put in 5%.

46:37I say, okay, that's fine. I got 10 other people who are willing to do it at 2%. And like, that's just supply, you know, it's the supply demand curve. Like there's just a demand that is willing to absorb all the supply at the price venture is selling, which is two and 20 with this, maybe call it the GP commit as a component of that. Okay. I figured it out. So the question of who's to blame, the answer is effectively nobody. It's two things, I think. One at the start and one at the end. Big wall of capital wanting to get into venture capital funds. It's rational for VC funds to raise money and then to play.

47:14We both agree. The problem is there's just not enough outlier companies built each year to absorb that amount of money. So as long as the demand stays high, VCs will be rational and there will be distortion on the founder side and delayed exits and so forth, as you've discussed. But until you can tune up the number then of breakout outlier, home run, power law companies to back, we're going to end up, I think, still here. So then the question of Jammin becomes, what changes first? Do we get more outlier companies first or do we get a decrease in the wall of demand for venture allocation? That maybe is the right question to ask.

47:52And look, this is why it's so hard to answer. I think, especially with this wave of AI, like companies, let's talk about open AI, however many billions of revenue they've got to in a couple of years, that is mind-blowing that you can have a company scale that quickly. It's mind-blowing, but you're seeing companies grow faster than they've ever grown. The size of the prize is probably bigger than it ever has been. I mean, again, go back. It wasn't that long ago where a Blockbuster IPO on the software side was a billion dollars. And so all of that is true, but it's still true that maybe the number of companies that are outlier isn't greater, but the size of the prize, if you're in one of them, is far greater.

48:29And so then it just leads to this interesting question of, again, back to like that funnel I draw, there's just a decreasing number of companies that are outliers at every stage. If you have a huge fund that's going to be balanced, you would just have to absorb companies that aren't outliers. Because let's say you're a series D fund, and I don't know, I'm going to make up numbers. Maybe there's six companies a year that really matter at that stage. If you have to invest in 15 companies, you could have a 100 % hit rate and get every single company that matters. But every incremental company you invest in is going to be dilutive to your returns, which is why either you're going to further concentrate as you get later stage as an investment firm, or you're just naturally going to have to widen the aperture, which will force your returns, which will be dilutive to your returns.

49:13Because there's only so many companies that matter. And the reality is no one's going to be in all of them. But I go back to why do big funds get bigger? It's like, well, the big funds have a lot of influence. They have a lot of brand. They have a lot of reputation. It's who the best companies at those breakout stages want to work with. And so it's kind of this recursive loop of that's why the big get bigger, because the big are generally the firms that those late stage, those quasi public companies want to work with. I want to underscore your point about companies growing faster than ever before.

49:40And look, OpenAI scaled from essentially nothing to, what is it this year? $3.7 billion run rate, or maybe it's trailing revenues, whatever. Huge number. But it's also showing up in other companies. Cursor, which just, I think they're closing around at 2.9, 2.5, somewhere in there. And I was reading that they grew from 4 million in annual revenue to 4 million in monthly revenue in an incredibly quick timeline. that's a pace of growth that's simply insane and yeah it's crazy i honestly i think i think cursor two and a half is undervalued but that's a different story uh yeah but that people are chasing those prizes i just that company probably won't go out until it's worth 20 or 30 billion so that means it's going to be another 8 10 years i mean it's just be wild yeah you see a lot of value accruing in the public in the private markets i think the interesting thing with ai in particular is like there's just going to be a lot of head fakes.

50:33There are going to be a lot of companies that grow really quickly and the growth curves kind of look like this and then they stall, maybe go negative. And some of them will either rebound back up or go negative and just kind of fade to irrelevance. And because what happens is you go to any big company, everyone's boss says to them, Hey, Alex, like I want, I want you to introduce efficiencies to our business with AI. It's like, it's a mandate. You say, I got to go do that. You're just going to go out and buy a lot of AI solutions because it's your mandate. And you might not have a clear cut ROI case to be made, but there is a demand for AI efficiencies in our business.

51:09I think you see a lot of companies growing really quickly off the back of that, right? You're not doing a full RFP. You're not really saying, let me evaluate three solutions. Just I need to buy it and I need to buy it now. I do think what's going to happen with a lot of the AI startups is there are going to be some that kind of are on that trajectory that are best of breed, that are N of one, that then continue. once we get a little bit more scrutiny on AI procurement and AI purchasing. But there will certainly be a lot that grow really quickly, that become commoditized, that grow really quickly, that are actually the number two or three in their space, and then they really slow down and they see a lot of churn.

51:42You know, we had Eric Vichery at our investor day not too long ago, and like he said this very well, which was, you know, like we expect a lot of the companies that we invest in to slow down or decline at some point in the next one to two years. That isn't what we said about kind of classic SaaS and classic software. It's what we expect to happen in the AI world. I don't want to misquote him. So if I said it wrong, he can correct us after the fact. It's close enough, I'm sure. Yeah. But there's, you know, like why we're investing in the companies that we're investing is because we believe that even despite that inevitable slowdown that will happen, like we're investing in best of breed companies that will then continue to grow once kind of the dust has settled in a lot of these AI categories.

52:20I appreciate you talking me through this. Watching venture capital from the outside is incredibly interesting and fun, but it's always good to get kind of the horse's mouth perspective on things. So thank you. And I'm going to say it again, cloudedjudgment.substack.com. I am a huge fan of reading it for a long time, and it's more popular than my blog. So you jamming. Okay, so now on to our favorite stuff, which is SAS multiples and kind of what's going on in the world of software economics. Over on clouded judgment, you had a chart showing quarterly performance versus consensus estimates for the last earnings cycle.

52:55And if you're watching the video, you'll see on the far right, we have 100 % of companies that had reported when Jammin put this chart together, in fact, had beaten consensus estimates. So to me, Jammin, that would imply that the SaaS market is incredibly healthy right now. And yet market enthusiasm for SaaS, as we discussed earlier in a multiples perspective, is relatively limited. So is this just clearing a low bar or is the public market being a little bit parsimonious with its multiples? Yeah. Yeah, you know, we'll see. I'd say it's always hard to draw a trend from one data point. But you know, like historically, and when I say historically, I'd say like the markets for SaaS got tough in, you know, 22 and 23, right?

53:35The SaaS occur, the SaaS apocalypse, whatever you want to call it, like selling software got hard as we came out of this ZERT period, people focused on cloud optimization, they focused on reducing redundant spend, right? There's just a lot of contraction and emphasis and focus on driving efficiencies, particularly around how you buy software. we've kind of been in this period for two years, right? So prior to that period, and even prior to Zurb, you know, like you'd see kind of 95 to 100 % of companies beat quarterly consensus estimates. You know, that, why is that? It's because there's a beat and raise model in software, right?

54:04Like slightly beat, you know, hitting the estimates is actually a miss, right? Because you've built in a margin of safety and you basically missed that margin. And people know you've built in a margin of safety. Exactly. They know you're sandbagging just a little bit. It's sandbagging, exactly. You'll get it. So in this period that was harder, the 22-23 period, you know, that dropped down to 90%. You know, now all of a sudden, 10 % of companies were missing the quarter's consensus estimates. And I don't remember exactly off the top of my head, but you know, and then companies report a quarter, but then they also guide, you know, we dropped from something like 70 % of, or 80 % of companies then guiding above consensus for the next quarter to 50 % of companies guiding ahead for next quarter's consensus.

54:44And so I'd say, you know, that chart, it's not 100%. You know, there have been some companies, software companies that have missed earnings. This is just like the longitudinal same basket of companies, you know, over a period of time, just so kind of, it's more of an apples to apples comparison. But I think there's about 30 companies so far that have reported Q3, like all of them have beat. And they've kind of in the margin with which they've beat has gone up relative to the last couple quarters. And so, you know, that's maybe more indicative of, hey, is the buying behavior changing? You know, we might also be getting towards the year end.

55:15and look like there's just a lot of positive reflexivity in the market today rates are going down you know trump's elected people say are the tax cuts going to be permanent is that going to be stimulatory is is lena khan out is m and a you know like there's just a lot of you know if you're more cautious about buying budgets i'd say everything that's happened over the last six months makes you less cautious yeah and so you're more likely to kind of spend that budget for 24 that you haven't that's sitting on the shelf and so it could just be like a budget flush that's what that's called that we're kind of heading into towards the year end so again i'm hesitant to necessarily say performance is starting to rebound because if we rewind the clock back to q4 of 23 which those companies reported those quarters in january and february of this year software performance really ticked up and people are like we're back um it turned out that was kind of largely just this budget flush well at least at least just my theory but you know other people as well it's just budget flush the end of 23 people had an huge budget that they kind of spend at the end of the year and the environment hadn't actually really changed it was just this kind of one-time thing we have a chart from cloud of judgment that shows the aggregate cloud software net new arr yoy growth chart and it went up as 23 ended and then it went plonk and then it went up again yeah and and so we'll you know we'll see if uh if one data point is a trend or or not and you know we again you're not going to know until it's obvious in hindsight and the market will move ahead of of ahead of that uh and so i think multiples software multiples have i think the median has kind of hugged right around six times over the last few years.

56:41And historically, pre-COVID, the median was around eight times. That comparison, just for reference, the eight times median software multiple from, I don't know, 2010 to 2020 occurred when the average 10-year was about 2.2, 2.3%. So eight times and 2.2%. Today, we're at six times and 4.2%. So rates are still higher. And ironically, as the Fed have cut rates, the 10-year has actually gone up i know i'm kind of 3.8 3.9 to 4.2 but i think that's just as as views of the strength of the economy have continued right and then maybe views of hey will inflation pick back up and so if you have a strong economy you don't need to cut if some of these tax cuts with this new president are made permanent is that you know i think you just have there's lots of reasons for why rates have gone up but yeah we're at six times today uh and so everyone looks at the historical average and say oh eight times like that should be a 33 percent multiple expansion but it's like hey let's remember that also was when multiple rates were low twos right now rates are low fours and so you know rates will have to change for for kind of multiples to expand or companies will need to we got to a two percent rate again even if we got to eight x yeah that doesn't solve a lot of the problems we discussed earlier for unicorns and stock companies that probably provides a a a more attractive ipo window it probably makes some m a a little bit easier to do but that's gonna like cut your fever from 103 to 101 degrees, it's not going to get you down to 98.6.

58:05That's right. That's right. That's tough. Okay. So one last question. I recently talked to the CEO of Amplitude, a public company at 2021 IPO, love Spencer. And I was reading through their earnings reports. And one thing that kind of caught my eye was he was talking about how the era of software, people trying to cut back on their spend and dealing with overpurchasing was kind of coming to an end. And that to me just felt very, very bullish for startups next year. And so I just wanted to put that to you and say, hey, do your portfolio companies and the boards that you sit on seem to be pretty optimistic about next year?

58:41I'm trying to get a vibe for January, Janet. Sure. I think we're seeing some signs of that. And I'd say you look at the hyperscalers and what are they saying? Hey, this focus on cloud optimization has eased and the focus on new workload growth has grown. And so I think you're hearing a lot of consistent messages from the folks who are giving us big public statements. I think that the thing to be wary of is in 21, right in the ZERP period, like everyone benefited proportionally, right? Like every company, whether you were the best of breed, whether you were the third in your category, like you all benefited.

59:16And so it's important to call out that as the, you know, as the software buying environment thaws, we're not going back to this, like it's easy for everyone. What we're going back to is it's going to be easy for the best of breed, the leaders in categories with differentiated products who, you know, have a right to win that incremental budget. And so I think there is a little bit of like a disillusionment that, hey, we're going to get this snap back when rates go down and it's going to be easy for everyone. But all of the muscle memory that's been built into every procurement team, everyone buying software over the last two years, your CFO like cracking the whip behind you about you can't buy this this product because we're already spending for something else in this org that's similar like no redundant spend sorry you don't get this standardized on that like that muscle memory around procurement of stuff like that's not going away okay right and so like that because it has been like whipped into people and so budgets might get bigger but there's still going to be a lot of scrutiny on them there's still going to be a lot of like why this versus that what's the roi what's the business case what problem does it solve how much revenue is it going to generate us how much costs are it's going to cut out jamin this was my attempt at ending on a positive note and i feel like you just brought in the procurement department and cfo's cracking whips you're supposed to be throwing some joy out here man yeah it's nearly christmas no look i i think yeah it is um i think it look it is what it always has been right companies that are differentiated playing in big markets are going to big build businesses and those who aren't are going to struggle and i think it's important just to call it out because we did have this period of disillusionment where it's like hey everyone's going to win and the reality is is everything over the last few years has kind of been a theme of just like reversion to the mean and like everything we're witnessing now is just is just exactly that um a reversion to the mean the reversion the mean where it's not reverting is the wall of capital looking to get into venture and that's going to remain distorted to your point about incentives but if you want to know which companies out there are the the breakout winners i would recommend uh airbyte click house dbt labs live kit and prisma which are the boards that jammin is currently on so if you want to know where he's placed his bets there you have it uh jammin a real treat i'm going to have you back on in like six months to talk about what goes on in the new year.

1:01:17Yeah. New administration, startups, exits and IPOs. But I'm really hoping that you and I get as many IPOs next year to chew on and look at as we are hoping, because my gosh, we have been starving these last two years. You and me both. All right, dude. Thanks for coming on. Jammin' Ball. Jammin' Ball on Twitter. Clouded Judgment over on Substack. He's the man. We'll have him back. Bye, everybody. See ya.