E64: Chris Paik on the End of Software and the Future of AI Infrastructure

0:04Welcome back to Turpentine VC, the podcast where we discuss the art and science of building successful venture firms, VC to VC. Today, we're joined by Chris Paik, General Partner at Pace Capital and Co-Founder of Thrive Capital. We discuss the evolution of VC and technology platforms, and explore Chris's frameworks for understanding AI's impact on software, as well as his three-brothers parable explaining the dynamics between different AI models. Chris also shares his insights on how infrastructure requirements shape the next generation of consumer companies. Let's dive in. Chris, welcome to Turpentine VC.

0:41Stoked to have you on here. Thank you, Eric. It's an honor and a privilege. Thanks for having me. Before getting into PACE and what you're doing there, I first want to focus or ask a little bit about Thrive because you were on early and helped bring the firm into existence, co-found the firm. and Thrive has kind of done some things different or kind of introduced some new ideas to venture more broadly. One in its incredible taste and kind of its sort of aesthetic of how Thrive has been built. And I think that's been partly influenced by you, but then also in its business model. And you write a lot about business model product fit, which we'll get to, but Thrive, you know, started small, I think 40 million or something, you know, first firm and now is, many billions under management.

1:25So has chosen to go a certain way and has coincided with what I think is different kinds of LPs entering venture, seeking sort of different kinds of return profiles and different kinds of investments, but also just alongside ACZ and others, paying higher prices than people thought made sense at a certain time. But in fact, we're actually prescient based on how big these kinds of companies have become. And maybe OpenEye being one of the most recent examples of that. So I'm curious if you can briefly summarize what you think Thrive has introduced or sort of innovated on within venture and how kind of venture has evolved alongside your time at Thrive and now, of course, Pace, which we'll get to.

2:11Absolutely. Thank you. That's a kind introduction. I don't know if I would have been as charitable in describing my level of involvement. But I, gosh, it was so fun. That's like, honestly, that's probably the first thing that I think about. It was really, really, really fun. I think the way that I view Thrive is kind of like my alma mater. I learned so much at Thrive and we did so many great things. I was very lucky to be a part of it. For better, for worse, learned on the job. It was my first job out of school. I think it's sort of like not lost on me that the only reason why we're having this conversation is survivor bias.

2:52Like in a million peril other universes, I didn't make it. In this universe, though, I think Thrive was a startup itself. It was just a venture capital firm. Same dynamic of incumbents in the industry that you have to be a David to their Goliath. I think if there's something that I really, I'm very grateful for learning this craft at Thrive is I think being kind of geographically based in New York, no one, nothing comes to you. You have to be offensive. You are default on a plane. Calls never end with, let me know when you're in town, because it's never a certainty that people are coming to you.

3:37And I really love that really low level DNA and coding. In the startup ecosystem, it's also, you know, it's easier maybe to be like the underdog and for people to underestimate you. I think I'll speak for myself, like in my experience at Thrive, it always felt like we were, you know, we had to, we had to do more in order to win. And I think that was internalized to everybody at the firm. And also totally, it's totally fine. we're all so hungry. So yeah, maybe hunger is the best word to use to describe it. You know, I think the strategy, if there's maybe one key insight that I didn't even really have an appreciation for while I was at Thrive, and maybe with the gift of hindsight, I understand it more clearly is, you know, technology, the internet created these monopolies, these these parallel dynamics of enterprise value distribution.

4:33And I think as investors, we're like almost prone to not fully understand how dominant market leaders are. You know, if you were to ask somebody, you know, how big is Coke and how big is Pepsi? I think most people would be like, okay, well, like Coke, Pepsi's got to be pretty big. I mean, it's number two in the market. And I think that's historically been true for a lot of for a lot of conventional businesses. But then along comes the internet and totally changes the dynamics of it. I feel like as investors, we're still trying to find alpha in what are overlooked areas. And so the alpha couldn't possibly exist in the category leader because that thing's got to be fully priced.

5:23I mean, it's a category leader. Nobody knows about it. I think it's this mental idiosyncratic dynamic where the entire capital markets thinks that the trade can't be that obvious, right? It can't be so obvious that the market leader is the best investment in the space. There's got to be something else going on here because otherwise, how can I be clever and make money? Turns out actually, sometimes the market leader is just the winner. And I think this is one of the reasons why the FANG trade was the dominant trade for a dozen years. And most people missed it. Because I think as investors, we're just like, we want to be right and clever.

6:09And if we just invest in the market dominant thing, we can be right, but we're no longer clever. And so where's the fun in that? And so you have these market leaders that are just kind of structurally overlooked by the capital markets. And so just that dominance, that moat, that gap in the monopoly dynamics is very easily underestimated because of investor psychology. It reminds me of a conversation I had with Matt Huang from Paradigm in 2017 or whenever they were getting started. And he was saying one internal division they were having at the firm is Bitcoin was the obvious trade or bet at the time, but everyone there was so smart and so clever and wanted to be seen as so smart that they were sort of psyching themselves out of that because, you know, anyone had the opportunity to just invest in Bitcoin.

7:00They could do that. It didn't feel clever enough. It didn't feel that they would get the right credit. Exactly. A hundred percent. Right. I mean, like at the end of the day, we're all, most of us are ego-driven on some level. And that is a huge driver of how we do things. And so a meta understanding of that, more broadly, actually yields pretty interesting insight. I spoke to one of the leaders at one of these multi-stage firms. I don't want to out them. But one thing he was saying was that he worries for the firms like Benchmark or like USV that are staying more disciplined on fund size, which I think you guys might be doing too.

7:39We'll get to that in a second, but that they might have a structural disadvantage where because the firms who have more money are able to hire, you know, pay higher prices, more money, that it might just be a better structural product for the founder, at least on that dimension. And I'm curious if you sympathize with that, but more broadly, I'm curious about the approach that you're taking at pace and how you will think about your product, part of which is your strategy and your fund size going forward because you have your success, you have all of these options. How have you thought about these trade-offs as it relates to the game that you want to play?

8:14Yeah, it's a really good question. I forget who characterized it this way. And I'm remiss because I want to give them credit. But every firm is basically, I'm sure you're obviously familiar with the competition model at venture firms, two and 20. And I think there's this question of like, are you a two firm or are you a 20 firm? Yeah. Depending on which one you are, it kind of really changes the nature of how it's played long-term and the long-term motivations of the investors at said firm. Look, I don't have a crystal ball. If I had one, maybe this podcast would just be 10 minutes short. My instinct is that the pendulum swings.

8:59And it swings back and forth all the time. And right now, we're kind of in this swing motion where firms are aggregating capital and weaponizing that too in order to flood the market. And the corrective cycle on the LP side of things is that feedback loop is so dilated that you're probably able to do a lot even before the first crows come home to roost. And even if they even do, if beta actually is just excellent, then everything goes well. The two model really only starts to fall apart in bad beta environments. And that's when the 20 model starts to shine. I think that the interesting part about this business is information is not perfect.

9:53And so you can out hustle. You can beat people to the punch. If you spend more time being a prepared mind, you can show up and invest in a company before the rest of the market wakes up. And so in this world where there's only 100 % of every company to go around, the people that can do this well at the early stages and really own a large portion of the winners, not just economically, end up also owning it reputationally. And one other dynamic I would say is every firm has brand and reputation. And interestingly enough, those are two distinct quantities. Brand is some quantity, and then reputation is a completely different quantity.

10:45Over a long enough time horizon, those two things converge. Usually brand converges to reputation, not the other way around. But yeah, in the long run, markets are a weighing machine, not a voting machine. And so I'll be very curious to see how this continues to play out. You asked, what are we doing here at Pace? I think the goal here is to obviously invest in, empower, advise, be a part of building the greatest companies in our generation. And we think that we do that by also attracting the best craftspeople on the investing side. And so it's our job then to create an environment and a firm that people who want to be world-class investors and hone their craft and get better at it want to be a part of.

11:39Yeah, I think there are plenty of empire builders out there. And honestly, I really respect it. I really respect it. I understand why it happens and particularly the empire builders that are good at it. I think, at least at PACE, I think we're building something closer to a temple. And what does that mean? We think that venture is a craft. We think it's a services business. We think that the more you practice it, the more you study it, the better you can get at it. We're not shotgun investors. If anything, we're probably snipers. We're not heat-seeking missiles. And we develop theses. We have views of the world and use those views to sort and filter how we prosecute deals.

12:27It's not uncommon for us to be the first people to reach out to companies. We have this sort of informal motto internally, which is if there's a deck, it's too late. If the company has already got all of its ducks in a row, and it's like ready to march out to the capital markets and seek the highest price. I don't know if that's for us. There are firms out there that have much better brands than us. There are firms out there that can pay much higher prices than us. And so it's like, okay, where can we win? I think it's being thoughtful. It's getting there first. It's building conviction before other investors that might be less prepared would need more information to get the same degree of conviction.

13:09And so to the extent that that is a kind of investing that is attractive to other investors, hopefully we can build out a team of people that practice in that way. We have language internally, like we're all pushing ourselves to be great or pushing ourselves to be good or we're pushing ourselves to be great or pushing each other to be great. And we have this idea of like new PRs. It's not that necessarily there's quote unquote untapped potential that we're not executing against. We're giving it our best here. We're peddled in the metal. It's just that our best is also getting better. And so every day, we think we can set a new PR.

13:49I'll shamelessly steal another slogan from the browser company, which incredible culture. Your biggest investment, right? Or one of them, at least. Yes. And they have an internal slogan, which is better as possible. I think people who are attracted to this kind of idea and pursuit of excellence are the kinds of folks that we hope to attract here. Hey, we'll continue our interview in a moment after a word from our sponsors. How deep do you go to seek out an answer to a question? Maybe you've spent hours clicking the source links on an obscure Wikipedia page, or maybe you're even the type of person who checked out the entire shelf on the topic at your library.

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15:37Yeah. I'm curious to what extent you think you're also taking, you know, market risk with your approach, or is it mostly just execution risk and maybe put differently? You know, you mentioned venture as a craft. I think, in my opinion, the most sort of revolutionary model in venture over the last 20 years, maybe longer, is Y Combinator in their ability to get scale and special economics in some of the best companies of the last 20 years by sort of changing the model, really, changing the product of how they serve founders in ways that I don't think anyone has really done since. they've shown the venture can be something different and maybe there's just that was a one-off and it's hard to recreate things like that.

16:24And, and, but I'm curious if in the next 10 to 20 years, venture is going to look pretty similar to how it does now with YC is the great, you know, what went off or something, or if for some reason venture is going to evolve and look like something different because, you know, many people say it's a craft. I wonder if it's also, has the potential to be productized or sort of innovated on in the way that YC has. I hope the industry changes, right? It's got to. I mean, capital markets are so dynamic, responsive. Venture capital as an industry isn't even that old. I 100 % agree with you that Y Combinator as an invention, as an idea, brilliant.

17:11Network of fact, alumni network, special economics, brand, prestige. There are so many things that are so thoughtfully executed on and the system design is so elegant. I really respect it. Asked if we're taking market risk or execution risk. I think if YC is an example of market risk successfully taken, while I would love to think of us as creative thinkers, I'm skeptical that any self-description that comes remotely close to that would be self-aggrandizing. And so we must be just taking executions. We just think that adventure as a product can be improved upon and that we have a way of pursuing investments and making investments that it's differentiated and will outperform others, even though it's largely the same game.

18:10I think since Y Combinator, I would point to these mega funds as really interesting changes in the fabric of the market. It's possible that the cash flow coming off of that too is more than enough at large scale to incentivize, attract, retain incredible enough talent that outcompetes smaller firms. I think that's an open feedback, an open hypothesis for me. And it's like kind of waiting for like data points to be tied out. But I also think it's probably this sort of like pendulum swing. I would expect the capital markets to over rotate on the asset, like the aggregator model. And then like, it breaks in some way, shape or form, returns fall short, LPs aren't satisfied with, you know, sub 2x net, and then it kind of swings back.

19:06And I think I understand the convenience of concentrated allocation, but I also understand that on the LP side of things, it's just, they're returns driven. And 2xNet or less than that, it's just like not going to pay the bills. So I'll be super curious to see how the entire industry changes and evolves over time. My assumption is that it will continue to evolve. In the same way that the capital markets and private equity and hedge funds, like the invention of the LBO, the invention of the credit default swap, all of these financial engineering instruments fundamentally change the way that capital assembles.

19:50I think the invention of Y-Comp is so cool. So cool. And I'm going to assume that there will be other instruments that get invented in the future. I'm here for it. I'm here for it. I mean, like if there's anything, how do I describe this? More competition is good. No competition in the model equals good. And so founders will benefit. Us as consumers will benefit by better companies being, you know, existing. Now, is it a Hunger Games for the participants? Perhaps. But I think that's also something that we all sign up for. We, you know, if we're not good at this, we shouldn't be able to do it. It's an incredible privilege to be able to do this.

20:35Do you think the asset class will, or the amount of money in the asset class will be smaller or greater than it is now? I'm going to assume greater for a couple of reasons. There are three reasons, three vectors that I would assume leads to more money in venture. One is technological substrates explode, warranting more businesses being built needing more capital. So like the invention of LLM is amazing. That impact on like drug discovery, like general productivity. I mean, we're going to have this huge explosion of companies that will need financing, will need like, you know, growth capital. And so that is like the purest, most primary reason why venture dollars will increase, like aggregate venture venture increase.

21:34The other reason is the more available private capital is, the easier it is to stay private longer, particularly for businesses that haven't reached steady state free cash flow generation. And so if you go public and you have to be judged in the public markets and you're not putting your best foot forward, that can be tough. That can be really hard. You suffer massive swings if people don't understand your business fully. But if you're more fully baked by the time you go out and it's easier to understand the strengths of your business, I think that's probably not positive. What that means is that significantly more enterprise value growth and capture occurs in the private markets rather than in the public markets.

22:25And so we don't have these situations where Amazon goes public at $500 million valuation and then runs up to$3 trillion. These 1 ,000 Xs in the public markets don't happen anymore because it's all captured by the private markets. So I think that will also happen to warrant more money in venture and private markets and really crossover funds. The third reason I regret is a reason, but is true and is like, you can't deny it. I think venture, because of these large funds and ownership targets, I think VCs can foie gras companies. I'm sure you've seen this and heard it where a founder goes out and they're like, hey, I think I need like$5 million.

23:10And some VC who's a partner at a mega fund, they're thinking to themselves, how do I win this deal? How do I hit the ownership target? like, do we really even write$5 million checks? Asks the founder, like, authentically, genuinely, you know, what could you do with 10?

23:33Which is so great. That's so insane. It's insane that that question gets asked. It's insane that like the capital markets, like force feed companies to that degree but the double-edged that is you know the the capital demands on on on the fund side and like the ecosystem side balloon on the back of that so i to answer your question i expect yes i expect more money that flows in until until some of these like feedback groups on the lp side of things and returns start tying out and and and maybe with like one exception if like rates explode and like the risk-free rate actually exceeds you know whatever like the private markets are are returning then like then we'll see like structural rotation of the lp asset class out of venture but i mean zerf was like one of the best things for for venture because everyone's everyone's looking for returns and you know the the narrative and idea that it was coming from the private markets is pretty compelling totally i want to shift from talking about architecting a venture fund and thinking about venture as an asset class to more investing related frameworks.

24:46And I want to go to one of your most recent posts, which broke the internet, the end of software, or at least within our venture sphere. And I want you to explain behind this quote that you end with. You say, Vogue wasn't replaced by another fashion media company. It was replaced by 10 ,000 influencers. Salesforce will not be replaced by another monolithic CRM. It'll be replaced by a constellation of things that dynamically serve the same intent and pain points. Software companies will be replaced the same way media companies were, giving rise to a new set of platforms that control distribution.

25:17Yeah. First of all, I fully recognize this sort of like poke the bear-y dynamic associated with that. Turns out Twitter doesn't reward nuance. Though I believe everything that I put in that essay. I mean, we're starting to see it, right? I don't know how true or untrue Klarna ripping out Salesforce and Workday is and replacing it with homegrown builds. But if that's even directionally correct, that's crazy. And where we're going. And so if you think about it, at the end of the day, software is just tool. They're just tools. They're means to an end. They're not necessarily ends in and of themselves.

26:01And so if there's just like a lower friction, cheaper aqueduct for water to flow down, it's going to be that's like this real, it's like truly existential reckoning moment for the industry that has been largely cantilevered around SaaS as an incredible, like admittedly an incredible business model and value creator for many years, decades. You know, I think the standard approach is, you know, SaaS keeps the lights on with like steady returns and consumers the big swings that like you know sass can be fund driving sass can make the fund and consumer makes the firm and so all of a sudden we're like oh shit this thing this like this one leg of the stool doesn't exist anymore what what is it going to be it's just sort of like race to the bottom on pricing now i see everybody you know now we're talking about like you know you sell the service not the software you sell the outcome but that's just you know that's just one stop a lot on the way to the logical conclusion of like oh actually it's just a race to zero and distribution is the only thing that matters and so in a world where distribution is the only thing that matters okay who ends up controlling distribution what are those endpoints that we entrust with intent think about it this way like say you're say you're like the CFO at a company and you need a budget, annual budget, odds are you actually don't ever touch Excel, right?

27:41Odds are you ask someone to make the budget and they maybe ask someone else and that someone touches Excel. But we've already kind of abstracted away from person using the tool. And so what's going to end up happening is instead of humans as those intermediaries, it's just going to be agents, right? And so we're all going to exist in this mode of orchestration and conducting rather than actually using the tools themselves. And that's going to lead to wild productivity improvements. It's going to lead to insane reskilling and unemployment probably. It's going to demand for the welfare state even more because every time you have a productivity boost, you have dramatic wealth inequality and disparity.

28:35but if the internet took us from this amount of content to this amount of content, I would argue that AI and LLMs are going to take us from this amount of software to this amount of software. And that's just like a fundamentally different world. Again, one where distribution is everything. And right now, I think people still rely on switching costs and data portability and sales motions. like all of that basically goes away when you have free software competing with each other for distribution. People always say like, oh, but we have free software. We have like freeware. You know, yeah. In the same way that like we had NPR pre-internet, we had like public access rate, like there was free content.

29:25You know, you can go to the library, but we didn't have everyone making free content, competing with each other, making free content for distribution. And so we're going to have a crazy amount of free software. I don't even know what we're going to call it, but we're going to have this crazy amount of software flooding the market and it's all going to be free. It's all going to compete with each other for distribution. Right. And it's also worth noting that these influencers are on centralized platforms like Instagram or Facebook or Twitter or whatever it is. And so I don't know, I wonder if there's some sort of enterprise or SaaS equivalent, but yeah, it was interesting that in the 2010s, there was this sort of, you know, spree of funding consumer media companies, all of whom, you know, or most of whom certainly didn't work out to people's hopes.

30:16And a lot of the value were just accrued to, to the individual influencers, but mostly the platforms, you know, Facebook, Instagram, et cetera, that were able to sort of intermediate. Yeah. I mean, it's kind of crazy. It's so insane. But like, better positioned than ever. It's insane. It's so crazy to me. And maybe I'll like, like, go on a tangent here for a sec. I think one of the reasons why Apple intelligence is so interesting right now, why is Apple intelligence interesting? Well, first of all, I think if you're trying to control distribution, you basically want to be as close to the human, close to the first mental hop as possible.

30:59I think one of the reasons why Google has lost a lot of the search war to Amazon is because we used to search on Google. The flow used to be like going to Google, searching batteries, space, Amazon, and then clicking the first link and then buying batteries. We don't do that anymore, right? We open up the Amazon app because we're just basically doing that first mental help already. And then we search batteries inside of Amazon. That totally changes Google's order in the firehose distribution of intent, capture of intent, and then firehose distribution intent. Like, whoever owns that first mental hop basically owns the resulting intent.