Has venture capital lost the plot?

0:08Welcome back to another episode of Venture Unlocked, the podcast that takes you behind the scenes of the business of venture capital. I'm your host, Samir Kaji. My guest today is Micah Rosenbloom, managing partner at Foundry Collective, one of the longest standing and respected seed firms in the industry, with early investments in companies like Uber, The Trade Desk, and Coupang. What makes Founder Collective atypical to most successful firms is their decision to keep fund sizes small. In fact, despite their success, they've never raised a fund over$100 million in a market where nearly every one of their counterparts has scaled up dramatically.

0:42In this conversation, Micah and I dig into why they've stayed so small, the data behind it, including the study his team ran on 25 years of venture capital exits that found that the median outcome of the top 500 exits over that time frame is about$2.7 billion. Micah is a two-time founder himself and someone that I find to be a very clear thinker when it comes to venture capital. I think you'll really enjoy this one. Now on to my conversation with Micah. Samir Khadji is the CEO and co-founder of Allocate. Allocate and Venture Unlocked are independent of each other. Any statements or references made by Samir or his guests regarding third-party investments or securities are solely their views and opinions and are not intended as investment advice or an endorsement of such parties or securities by Samir, his guests, or Allocate.

1:31Allocate or its clients may maintain relationships with or investment positions in guests, third parties, or securities mentioned in this podcast. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Micah, it's great seeing you, man. It's great to see you. Only thing better would be if you were here in New York in the 98 degree weather, but we'll do it remotely to start. I think I'm going to pass on that, although I did get some of the New York heat and humidity just a few weeks ago when I was out there. Definitely a far cry from the Bay Area where it's so temperament here.

2:04But I always like to see you and, you know, you posted a couple of things that I found interesting, which inspired this conversation. And I think they're very topical. Before we go into those posts and dive deep into some of the observations you had in the insights, why don't we start with the early days of you joining Founder Collective in I think it was a year two or three? Yeah, I mean, to start, we really kind of built this firm randomly and not really out of our own experience. So as the name suggests, we're all founders. I graduated in 1998 in the height of the dot-com boom. And I started working in Endeavor.

2:43They were an upstart talent agency. And I thought that was the coolest job ever that I got it for working with Ari and Emanuel and Ari Greenberg and like movie stars and so forth. And then there was this dot-com thing. And I was like, wait, that may be the cooler thing than even working in Hollywood. And my roommate and two other friends, we started a company. And that was really like the beginning of my sort of entrepreneurial venture career because one of our friends from college, Bill Trenchard, said, let me join your board. I can show you how to fundraise. We were like, oh, my God, this is amazing.

3:14You could be 21 and raise millions of dollars. Turns out you still have to build real value. That's a whole other thing. But we bought the URL handshake.com. I wish it was the handshake of today, but we were early owners of that URL. and yeah, we built a services marketplace like Thumbtack or Handybook and ultimately it failed. It's a long story we could talk about another day, but I just got caught by the bug. I was like, this is amazing. Like we can build our team, our own culture. We can hire the types of people we want and people worked night and day. That was good and bad. And we can birth a product that is like something new to the world, but we failed.

3:52And it was, I've been thinking a lot about this. I was like almost a bit depressed when the whole thing, you go from the top of the mountain to the bottom very quickly. And I think that I like I think about that lesson often now that like things are fragile at all stages. You can be raising and we raised twenty five million dollars for that company in two and a half years. And then I hadn't, you know, barely a penny in return. And so I went to business school and one of the first days of business school, I'm in a negotiations session against Dave Frankel. and we're like, we're in the grill at Harvard Business School, which is in the basement.

4:26And like everybody else is finishing and having a beer with their, and we're still going and going. And like, finally, finally, like he wipes the floor with me, crushes me. And I'm like, oh man, God, I hope I never have to negotiate against this guy again. And he drives me home because we both lived in across the river. And he was so nice. I was like, wow, like we just did this intense fake negotiation. And I kind of liked this guy, even though I lost miserably. And we sort of became friends. And then obviously Eric Paley and I, who is a good friend and section mate of Dave's, he and I co-founded a business together.

4:59We became very close friends. Dave was our first angel. I did it again. It was much more capital efficient. We built a hardware software company based on some technology out of MIT and it was in Boston. And so I'd started a company in California, moved back East, thought I'd go back West and then spent the next 10 years in Boston. And through that, there were a few observations. One was it was hard to raise early stage money in Boston. That was the beginning of when a lot of those funds were moving to the West Coast. People forget CRV stands for Charles River Ventures based in Boston, now largely a San Francisco based firm or Bay Area based firm.

5:37A lot of that was sort of going on at the time. And so the East Coast was really almost impossible to raise early stage capital. There were a handful of firms. So we saw that. The other thing we saw was early stage capital in general had started to dry up. It was just hard to do seed rounds. Thank God for Dave. Dave wrote a six-figure angel check into our company, which we needed to get going because their VCs weren't playing in that. They were barely playing in sort of seed and early A. And then we just, we saw an opportunity to build a fund that really, now it seems trite and cute and everybody, but like jeans and t-shirts and former operators and less of a banker culture and less of a like formal finance culture and more of a, we've been in your shoes.

6:23And I know that now seems obvious, but in 2012, when we sort of started ideating around this, and Eric and Dave raised the first fund in 2012, kicked off, sorry, 2009 was the first fund. It really was unique. There really weren't Koppelman, maybe Clavier, a few other folks. And so I think we had a different ethos and a different kind of value proposition. I think we still do. I just think it's a much noisier market we can talk about. But that was really the DNA of the firm. And then the last thing I'd say, which we've kept, like any operating company, have said a few principles that we've kept.

7:01One is we are structurally aligned to founders. So our product is for founders. And that means the decisions we make as a firm go back to that value prop, not for LPs, not for GPs, not for somebody else, but truly with the founder mindset or with the founder as the customer. The second thing is we've really preached capital efficiency. I write a lot about this in my LinkedIn posts, but also just that more money isn't always better and that more money doesn't solve problems. And we've created stickers, we have pamphlets. I mean, we've really tried to hammer this message home that we're not against fundraising, but just that this view that fundraising is the goal is just flawed.

7:42And we've seen more companies struggle because of it than benefit. And then And the last thing we always talk about is the weird and wonderful. I've got, we've got a whole bunch of, I think you've been in this room, but we've got a whole bunch of plaques behind me. And look, we're in a baby toy company, Hotel Tonight, Hoopong was a Korean-based e-com company. So like, we have just seen that success is often weird and unpredictable. And that's where we got to look because by definition, the themes are too late. If we look back, I mean, obviously that was 15 years ago, roughly when you joined in 17 years since the firm was founded.

8:18And at the time, you're right, there wasn't a lot of people investing at seed. I mean, you mentioned a couple of people, whether it's Jeff Clavier, there's also guys like Mike Maples, like Steve Anderson, on the East Coast, Roger Ehrenberg. There's a few people that were kind of doing it. That's right. The amount of capital at that stage was fairly minimal. And it's still small in the grander scheme of things today. If we look in 26 in terms of share of total dollars, if you look at seed versus everything else, and what I mean is real seeds, not the$100 million frontier,$100 million round for Frontier Lab or$200 million round.

8:51I put those as non-really seed companies. And as a result of that, we have still seen a lot of funds being raised since then. In fact, I think back in 2023, we did a study and said, how many funds or new firms are created between 2012 and 2023 in the US? And it was like 2000. It was something enormous amount number and many of your peers have actually gone bigger. So they might have started off with like$40 million funds. But as a result of seed rounds getting bigger, more capital at the series A round to be doing your pro rata, that$40 million fund in some cases is three, four, five hundred and not really a seed firm.

9:28How did you make the decision? And how tough was it to kind of stay at the current fund size, which is still in that$100 million range? Yeah. I mean, our last fund is still sub$100 million. We think, we like to say, there may be some exceptions, that we are the only branded seed fund that has stayed sub$100 million. Certainly, we're probably one of very few, if any, that are on their fifth fund and still under$100 million. I think for us, it wasn't so hard in the sense that we knew we were in the fee game because the difference between$100 and even$200, yes, it is materially more fees, but that wasn't how we defined success or meaningfully different in terms of the incomes or the ability to do the things we wanted.

10:13We were able to do the things we want. We have to stretch like any other startup on 95, but we could do the things we want. I think our view was, one, the founders needed optionality. We think the lesson we learned over and over again, Eric and I sold our company for$95 million. We were about to raise a Series B. And thankfully, we didn't. How would things have played out? I don't know. But I'm glad the financial crisis hit. A lot of things could have turned that into zero. And I think that is my lesson across many startups is there's so much macro influence. There's so much timing. There's so much randomness that you need optionality.

10:51You need flexibility, and a small fund allows for that. A big fund forces a big outcome, and it's much more binary. And we can talk about the data behind that. So it comes back to multiples, that just the law of numbers and the data shows it's easier to multiply a much smaller number than it is a much larger number. We can talk about that. I agree. The big funds are playing a different game. And then I think I've never viewed success or ambition as a function of how big your fund is. To me, it's all about performance and the satisfaction of my entrepreneurs. Those are the things I care about. And if I do those well, my LPs will be happy.

11:28And by the way, we are collectively the largest investor in our own fund. So nobody cares more about the multiple than the partners. And so that's kind of how we've thought about building the firm. In many ways, it's kind of the old way of building a firm. maybe more similar to the old benchmark, but very much aligned to our values and our ethos. When you talk about that, obviously, that creates a lot of alignment, both internally, in terms of what the philosophy is, and your experience as founders, really kind of informing what you want to do. And from an LP standpoint, I don't think there's many LPs that would disagree with smaller funds, have the opportunity to produce more alpha.

12:10And yet, so much capital goes into the big funds, which then have to deploy and get those$10 billion type of outcomes. And we look back in history, and there's been some companies that have been very capital efficient and got to great outcomes. Let's say the Trade Desk is one, Viva is another one. Even WhatsApp didn't raise a ton of capital before ultimately selling for$19 billion. But more and more, that model has started to break because you have Series A and Series B investors who are now investing out of$1 to$2 billion funds, sometimes even more than that. And the whole model there is a$25 to$50 million check to start off is just an option check for much more down the line.

12:49And so you almost start off with companies that you want to invest in that are capital efficient, but often don't have to go down this treadmill where because the market has grown, the companies that are successful are not capital efficient because they're pushed to take on capital. How do you reconcile the seed stage of capital efficiency, knowing that some of these companies are going to go on to be not capital efficient, given where the markets are? And, Kennelly, you see this, too, where on Twitter, everybody seems to drop a video around, we raise a Series A, and it's a founder talking, or Series B, and it's$50 million.

13:23And it almost becomes looking at sort of your neighbor and saying, can I build a bigger house? And in this case, it's really the size of the fundraise. Yeah, look, it's a real problem. Why I say it's a problem, I think it's creating a sense among founders of keeping up with the Joneses. You're sort of alluding to that. It's like, well, my company went from zero to 20 over a couple of years, but like, it's not anthropic. So it's meaningless. I think that psychology is awful because it's hard to go from zero to 20 in anything. And, and I think it's created this funny psychology that isn't healthy.

13:55I think the other problem is recruiting gets really hard because you're competing against these crazy outliers that, by the way, we'll see what happens in terms of exits in the stock that these people have, but they can pay a lot of cash. And so it's created all this venture capital, particularly at the top, but even across the whole ecosystem, just makes it really hard for a good company to recruit engineers if you're not one of the top, if you're not a lab or one of those. So I think it's been tricky. I think what has changed in the way we think about it is our product isn't for everyone. If there are founders who are going to raise that$100 million seed round because they're shooting something into space or they just feel like they need, like that is not a good fit for us.

14:35And we probably won't take the meeting. I mean, we'll certainly engage with the founder. But like at the outset, we'll say if you're raising 20 or 50 or 100, like we're just not a good fit for you. And I think we've sort of thought more like a builder, like who's in our ICP, who's in our ideal customer profile, and if they're not. And so we have a market segment. I think there are still plenty of founders. We see them every day who realize this math and say it's hard and I don't want to sign up day one. I think the knock on this has always been, well, there's adverse selection. You're not getting the most ambitious.

15:10Look, I'll concede. There may be some founders who do go on to build. Elon wasn't coming to us. It would have been nice. But I will take those odds. My job is to find alpha. And that means I've got to find the limited amount of value there is in the startup ecosystem. I've got to hunt for that alpha. And there may be categories that I just can't, you know, founder profiles, I just can't satisfy. And that's okay. Investing is all about like staying principled, staying in your lane, making the best bets you can in that domain. And so that's how we think about it. there's a quip you probably hear this all the time i'd be curious i think you'll smile when i says you got to play the game on the field got to play the game on the field everyone says that and to me i always smirk because i'm like got to jump off the bridge like there's a little bit of this implication that like you're an idiot if you're not doing what everybody else is and like to me like investing 101 if i've learned nothing from all those books i've read and my mba is like don't follow the herd like if everybody's going right consider going left and And yet what I hear when I hear play the game on the field is like everybody's doing, everybody's raising a bigger fund, paying higher prices.

16:19And look, to some extent, we're a function of that. We operate in that environment. So there is that. Our average valuation has gone up. But I think our job is to find outliers and not just do what everybody else is doing. One of the ways to do that is stay small. If everybody else is getting bigger, then maybe the thing to do is actually try to be a little bit different and play a slightly different strategy. If everyone's deploying at 3x the speed, maybe we slow down a little bit or at least take a different approach or invest in a different, if consumer is out, maybe it's a time to look a little more a consumer.

16:53And so anyway, that's kind of how we think about it. Certainly very different than it was, like you said, 15 years ago. Well, I do hear that all the time, which is play the game on the field. And a lot of it's obviously driven by incentives, right? People are incented to play the game on the field because in times like this, when you have an extreme bull market that then coincides with a super cycle, in this case, AI, which I think you and I can probably agree, this is the most transformational technology event that we've seen. You just have a lot of froth built into the system. You graduated in 98, so did I.

17:24So you and I are exactly the same age. We went through the dot-com bubble together. And so you kind of see the things. And there's always things that definitely rhyme and are going to be the same and repeated mistakes. There's also some things that are fundamentally different. Obviously, the adoption of technology today is far different. The distribution of it is. 100%. And the top 1 % of outcomes are going to be materially higher than the last super cycle. And you look at that, even something like an Amazon or Google, then you go to the Facebooks and the Ubers, and now, of course, Anthropic OpenAI, SpaceX being materially higher.

17:56But the average valuation exit, like for a non-1 % company, hasn't really changed too much. It's still sub 100. But we're now underwriting, as if all these companies are going to be the top 1%. You had this really interesting post. And you went back, I think 25 years, and looked at or your team did, yeah, alongside you around all the exits that were large. And there were some really interesting things around the companies that are over billion 10 billion, even north of 100 billion. If you don't mind for those that haven't seen that. Yeah, maybe describe a little bit what it actually told you. So maybe a little bit about the study and then interesting insights that came out of it.

18:36We've been saying this for years, which is there's no question exactly what you just said, that the top handful of companies, literally count them on your hand, the exits have gotten bigger and bigger. And exactly what you said, you took the words out of my back, Google, or before that, Yahoo, AOL, and now to SpaceX. I really never thought we'd see a trillion dollar company at least this quickly. Like I don't even think I ever I thought of economies being trillions of dollars, not single companies. So it is amazing. And take nothing from Elon's responsible for two of them or two like two of the top five.

19:09So like it is exceptional. But I think what we wanted to say was like over this period of time, what was the median outcome of an exited company, an actual exit of the top 500? And in the after doing the analysis, we found the number hasn't moved that much. It's about$2.7 billion is the median value of an exited company, the top 500. And so you sort of say to yourself, if you're building a fund, if that's the median, like, you know, and you own 10 % of that company, it's pretty tough to return even a billion dollar fund. It's pretty meaningful for a hundred million dollar fund. You can, you that's a couple multiples of$100 million funds.

19:53So that has sort of validated at least the hypothesis we had. Now, I fully recognize a lot of these big funds and a lot of these LPs and these big funds, the minute they hear median, and I've heard this on podcasts with Mark and Ben and of course we're not chasing medians. But to be clear, this is the median of the 500 biggest exits. And this was over 100 ,000 companies that have been started in the last 25 years. So just to put it in context, the probability of starting a billion-dollar exited company over the last 25 years is 10 times harder than getting into Harvard. It's about 0.45%, meaning of those 100 ,000 companies that have been started in the last 25 years, 400 and some odd have exited over a billion.

20:41And Harvard's undergrad is like 4 % admissions rate. Look, I take nothing from the ambitious people who want to be the top 0.4%. I just don't want to build a strategy. It's hard enough to do what we're doing. I don't want to build a strategy around a handful of companies. We have over a dozen companies on that list of over 500. Those were not easy. And there was a lot of, as I talked about before, a lot of randomness, a lot of timing, a lot of luck. I think the founders would agree. like even founders of some of these massive companies, I think if you put the Anthropic folks or the OpenAI, like I think I've read this, they were surprised at how much uptake there's been.

21:23So even the founders themselves don't know that they're in the exceptions of the exceptions. And so that just leads me back to this idea of like, what is a sensible size fund given the data? If we say good outcomes are a couple billion dollars, can we build a fund where that exit moves the needle? and I don't need to get into one of four or five amazingly crazy big companies. And just your point about the big funds, I do think they're playing a different game, which is they can get into those companies much later. And so if those companies do shoot the moon, as some of them have, they pick up those gains.

21:59To me, that's just a different business. Whereas I have to go in, by definition, before any of that exists, before product market fits. So it's harder for me to know which are the next SpaceX. Like, I'm just trying to build just some exceptional venture-backed companies. Well, yeah, anyone actually that says they know what the next SpaceX is, like, I would run the other way. Is it healthy if they actually know those things? I mean, you're taking your own thesis. Obviously, you have your own methodology, like the type of founders. You're going to be very founder-focused at the stage you're investing versus investing off a spreadsheet, which a lot of larger investors can do because these companies have turned over so many carts.

22:36The thing I struggle with, and I'd love to give your thought on this, is you look at the backward-looking data and say, OK,$2.7 billion is the median of the top 500 companies in terms of exit. Obviously, when you get to that first layer of the top, top companies, it's like$25 billion, which you own 10 % of a$25 billion exit,$2.5 billion. If you have a billion-dollar fund, that's a$2.5 billion exit, which is great. And some of the top firms are getting into those type of companies. One question I have is when you think about big firms, this is all this thing, big firm, bad, small fund, good. Some people say it the other way around.

23:07I think that's the wrong argument. I think these are just different economic models, which we'll get into in a second. But is there anything that causes you a little bit of pause of, is that$2.7 billion really indicative of the future? And the thing I struggle with is human beings just tend to be very linear. Like I never thought a company within five years would go to a trillion dollars and do$50 billion plus in revenue. I've just never seen it. And so I'm not, as an ex-banker who also lent to companies during the dot-com, I tend to be a little bit more on the conservative side and not fully swallow the blue pill.

23:41But at the same time, I look at this new era that we're in with AI and I say, well, what is going to change over the next 10 to 20 years in terms of median outcomes of the top companies? Again, I think there's going to be a lot of expensive mistakes. But do a lot of the sins get absolved because the power law is so amplified with that top 1%, which instead of 2.7 could be$4 billion or$5 billion? Yeah, look, I think that is the underlying logic of why the big funds are getting bigger and why LPs are chasing those few names. Only the future will tell. I don't know better. Your guess is as good as mine, better than mine, perhaps.

24:17But what I observe is over this long period of time, the numbers have stayed, you even said like$100 million exits. We see them all the time. If I look at our portfolio, like thankfully, we see a lot of those types of numbers. And they don't matter to the big funds at all. And I think they should matter. I think they should matter to the founders. They're life changing. Life changing money is still life changing money. You don't need trillion. You don't need those types of exits. So I think to founders, being able to sell your company, particularly if it's your first exit for$100 million and if you own a decent part.

24:47So I think that's still a truth that will matter in the market and will influence how founders think about it. And I think the other thing I witnessed on the field, and I'm curious if you see this, is the average valuations are going up. Ours has gone up a lot. Let's say they've gone up three to four times over the last decade or two. I actually think dilution is also going up. So I think this thesis that, yes, the exits are bigger, therefore we're going to do better, I would question whether it could go the other way, which is everyone's paying higher prices by a multiple than at least a decade ago or two decades ago.