Unpacking "A Crisis Moment In Seed"

0:09Welcome back to another episode of Venture Unlocked, the podcast that takes you behind the scenes of the business of venture capital. On this week's episode, I sat down with Rob Go, co-founder and partner of NextView, to discuss the shift in seed stage investing and what seed funds need to consider to stay viable. Our conversation was sparked by a three-part series of posts that Rob wrote, the first of which was called A Crisis Moment in Seed. The link for Rob's posts are on the Venture Unlocked Substack. And during our conversation, we spent a lot of time talking about what inspired the post for him and how seed managers today should adapt to the shifted market.

0:41For anyone investing at Seed, this is a must listen as Rob shared so many insightful views. 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. Allocate or its clients may maintain relationships with or investment positions in guests, third parties, or securities mentioned in this podcast.

1:18This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Rob, I really appreciate you being on. And this conversation is going to be really interesting for me because like you have thought a lot about it, but the world of venture capital, the evolution of it, you recently wrote over the last few months, a series of blogs around the seed universe, but I think it actually spoke more broadly toward where venture is today versus where it was. And I want to get into that, but maybe a good place to start is giving us a little bit of your background and what led you to some of those thoughts that you had on the blog.

1:55Awesome. Well, thanks so much for having me. Excited to be here on the show. So for context, I'm one of the founders and a partner at NextView. So we're a pre-seed and seed-focused fund. I live in the Boston area. We have partners in Boston, New York, and San Francisco and invest across the country. We started the firm back in 2011, and we're currently investing out of our fifth fund, about to crack open our sixth fund. And so starting back in 2011, we were like one of the OG spin-outs. We were one of the few funds of that era that were mostly guys coming out of existing venture funds, right? If you recall, most of the other peer funds at the time where angels were institutionalizing.

2:33And so we've kind of seen most of the movie in terms of how seed investing and early stage investing has progressed from that time period through to today. And there's been a lot of changes in the industry. When we started the firm, one of my partners had this analogy that the venture business is kind of like the beer industry. And he likened the rise of seed funds to the microbreweries that were prevalent at the time. But, you know, fast forward like 15 years, that industry has changed a lot. And the venture industry has changed quite a bit. And there was a ton of maturation. There was behind closed doors.

3:11We had a lot of GPs who were like groaning about things that were different or more challenging than they used to be. And so that kind of just led me to write a few posts, trying my best to just synthesize everything I was hearing and feeling in a somewhat coherent way. Let's start with a little bit of the foundation right now. So you mentioned starting in your next few in 2011, I think you rolled out of Spark Capital, obviously an institutional firm. And at the time, there weren't a lot of seed funds. And if I kind of look back 15 years ago, that was kind of the start. And there's a number of things that made it possible.

3:44Obviously, cloud computing, making it easier to cheaper to start companies. But, you know, here in Silicon Valley, there was folks like Jeff Clavier and folks like Iden Senkud and Steve Anderson and a lot of more angels that became known as super angels. They weren't even called micro VC or seed funds. And then since 2011, there have been a lot of tailwinds, both in technology, really becoming ubiquitous. But, you know, we were in a capital environment where interest rates were low. So a lot of capital was going into things like venture. And we saw the number of seed funds go from a small handful that you could probably put on one whiteboard to several thousand.

4:22And so talk a little bit about maybe before we get into this particular blog post, what did you see, I guess, in the main evolution and the themes of like 2011 to 2024? Right. Yeah. So one other early pioneer in the space was Michael Deering, who I worked in his department at eBay many moons ago. And frankly, I had a peek into what he was doing as he went from being an angel investor to starting Harrison Metal. And I said, hey, that's really interesting. And that points to one of the issues, right, with seed investing is it is the lowest barrier to entry segment of private equity, because the cost of starting startups had gone down.

5:02And so the cost of getting into the game as a seed investor had gone down as well. And so as you mentioned, right, like, one of the things we saw was just a flood of new entrants into the space. I think there was a tailwind, which was that, like, the original thesis was true, right? And so a lot of these funds and that vintage of funds performed really well as a cohort. And a bunch of folks were able to profit quite immensely from investing in really significant companies and entering in these businesses at pretty attractive prices, right? And so that propelled this segment of the market. And I think that just created a huge amount of competition.

5:42It actually enabled a lot of new company creation, which I think was really good for founders and for the industry, but it became really hard to decipher who is really going to be successful. What does it take to be differentiated and to break out? And as you said, we had this Zerp environment coming out of COVID that just like supercharged everything. And hopefully if you had a successful fund and you were in a position to get out of these companies and take advantage of those valuations. Hopefully you did. But at some point that came to a screeching halt. And that created a lot of pain and a reckoning for a lot of investors, not just seed investors, but a lot of the late stage folks who tried to pile on to that momentum.

6:21Yeah, I agree. And that was 2021, obviously, it was the peak of that ZERP area. And then 2022, obviously, interest rates rose up, it changed the risk dynamic and where money was going. And then you also had this new platform shift with artificial intelligence. And now what we've seen over the last couple of years with AI, both at the AI lab level, the infrastructure level now applications. But you wrote going back to what this all means for seed, because there are seed at the end of the day is investing at the early stages of the company. It still is a really important point of sort of capital to be able to take companies from inception, ID to now execution.

7:03But you wrote a post that I thought had a really compelling thesis around it, but it was labeled a crisis moment for seed. Maybe bring us through sort of the thought process and what that blog was really intentionally focused on. Yeah, so what I saw was essentially like four very significant forces that was making life much more challenging for seed investors. And I'd heard bits and pieces of it, but I'd never heard anybody really pull it together. And so that was the impetus for the post. So the first was what I alluded to, right? The industry was mature. Just like every single industry out there, venture capital is no different.

7:44And so it's gone going from a cottage industry to a more mature industry. And so the potential for profits get eroded as industries tend to mature. So that's number one. The second was actually two things. It's sort of the rise of two very formidable categories of competitors. And most simply, one was accelerators, but I think YC is really the most prominent one, where YC represents a huge portion of the market that essentially gets companies on a path that is somewhat orthogonal to what seed investors want to do. Because the seed investors have institutionalized, there's much more of a focus on check sizes, ownerships, ownership in order to drive fund returns.

8:27But a lot of YC companies kind of get company startups on a path that isn't exactly like simpatico with what seed investors are trying to do. So that's sort of force number one, and that represents a big chunk of the market. Force number two are the megafunds and the way that they participate in the seed market. And they do so in two ways. One is through scale efforts, so similar to speed run, similar to YC, in fact. So you have that. But they also cherry pick effectively the proven founders and invest at extremely high prices because they can't, right? And that ends up eliminating a smaller portion of the market by number, but also makes it – but for those categories of founders, it becomes really difficult for the seed investors to compete.

9:09And so there's a little bit of this squeezing on those two ends for the seed managers. Can we maybe distill down a little bit and double click on sort of YC? So YC, incredible scale, right? Companies, when you say they go on a path that might not be congruent with the seed model, maybe walk us through what you mean by that. Yeah. So YC has the deal that they offer to entrepreneurs, and it's pretty attractive for, I guess, pretty attractive for entrepreneurs, pretty attractive for YC. It somehow works out quite well. And the typical YC company exits and tries to raise their next round of capital at relatively high prices.

9:50And I would say typically those prices are in a zone that is beyond the kind of center of the strike zone for most seed investors. The other thing they're trying to do is for some subset of the IC companies, they're hoping to raise a series A directly. And again, that ends up being at a price in a scale that is beyond what seed investors typically target. And so it's not that most seed investors don't invest in YC companies. It's just that it ends up being a subset, or you have some seed investors who intentionally decide to have a separate YC strategy, right? It's like, okay, we're going to invest in X number of YC businesses.

10:31Our typical mode is to invest X amount of dollars for Y ownership. But for YC, we're going to do something completely different, which is sort of a valid strategy, but it is sort of orthogonal to what is the core strategy of the seed funds. Right. So then basically you get the squeezing from both sides. you have one model, particularly with YC, the number of companies that because of the valuation, the quantum capital, those companies are often raising from inception that are incongruent with the seed model and the bigger folks that are acting as this mega brewery, if we extend the analogy, can come down to the seed level, but the check sizes are much greater.

11:08And it's really more of a lifecycle sort of bet that they're making that they can put large amounts of capital into these companies over time. Yeah. Well, I actually think that what is happening here is related to the third observation, which is everyone has gotten religion around the power law. And that's one of the things that I remember when Peter Thiel was giving his lectures and then wrote the book Zero to One, right? The power law was kind of this novel thing. And oh, people underestimate the potential of the best companies. And it's very counterintuitive to think about the power law dynamics of this industry.

11:41But I feel like the industry has kind of internalized this and taking it to the extreme. So back to the megafunds, right? If you operate with this sort of power law mode, then if there is a founder who looks like he or she may be a true outlier founder, the megafunds can just invest in those founders' companies at pretty much any price, with the belief that if that company ends up being a super compounder, it doesn't really matter what your entry price was, because at some point, the biggest companies are so extraordinary that you're going to profit either way. And so that effect is pretty pronounced and drives some of that behavior for the megafunds.

12:21What were some of the other observations? You mentioned, obviously, this YC megafund sort of dynamic that makes it tougher for a seed investor to actually be successful the way they might have been 10 years ago. Maybe go through some of the other observations you had? Yeah, so it was industry maturation, YC and megafunds, power law is consensus, and then the AI platform shift, which is good news generally, because that creates a huge amount of opportunity for everybody. But what's odd is that this is a platform shift that everyone is ready for. And nobody, it's essentially a consensus innovation.

12:55And so this kind of pushes all the other factors to 11, right? Like, people believe in the power law, They believe in the power law even more because of how disruptive AI is going to be, right? And the effects you're seeing in terms of how YC or mega funds prosecute this market is more extreme because of this consensus around the AI innovation wave. When we think about investing in AI, and I do want to go into sort of the next, because this was a series of quotes you wrote, one of which was like, okay, there's a crisis here potentially for a lot of people. that may struggle with the business model that has evolved so much over the years that what worked before is not going to work now.

13:37And we'll go into what do you do, right? Because I think that's the obvious question of like, how do you succeed and thrive in an environment that's fundamentally changed? But going first to AI, so I think about AI infrastructure. So whether it's a company like Anthropic or OpenAI or any type of company that's really building fundamental infrastructure, those tend to be very capital intensive businesses. That's actually not a good product market fit between a founder going to a seed investor when they may need$100 million fairly quickly and often even beyond that. That leaves then the AI application layer, which you do have companies that can go to a seed manager.

14:16But it does appear that there are so many companies that are effectively doing the same thing. And it's hard to gauge the stickiness and really the long-term potential durability of those companies. And so how do you navigate in a world where AI infrastructure probably off limits and doesn't really make sense for a lot of seed investors, and now it's the application level? Yeah, I think that's such a good point, right? Because that's another one of the factors. It's that where a lot of the action was most exciting, I think over the prior four or five years, was in the infrastructure side of things, which doesn't really lend itself that well to the seed model broadly.

14:55There's some folks who do actually a very good job of this. I think Ed Simit Boldstart is effectively an infrastructure-oriented investor, and there's some others. But yes, the capital intensity ends up being really tough for the seed players. You asked a question about application layer innovation. I actually think that's one of the optimistic views that I have, which is we are barely into inning one, I think, of what will be a pretty, I think, prosperous period of application layer innovation. And I think that's an area where the seed funds should be really well positioned to play. And not that there hasn't been a lot of great application layer companies, but it's been pretty narrow, actually.

15:35A lot of things focused on the developers. Obviously, some really big companies focused on the legal space, right, where it's kind of a very obvious application of LLMs to that field. But we're really scratching the surface, I think, right? And to take an example, I think, and I actually think the other thought is that there's going to be a huge number of second order effects that arise in light of the fact that AI becomes ubiquitous. And like, we haven't even started to go down that path in terms of types of businesses that get created there. So I'm generally like pretty optimistic about that.

16:08Your question around like defensibility and how do you pick and how do you distinguish companies? Like, I don't think that's all that different than like than software, right? There wasn't massive differentiation, defensibility among SaaS companies. And so I don't think it's all that different within AI applications. And so I don't know, I actually think just the multitude of opportunities kind of overwhelm the fact that the seeming barriers to entry are somewhat low in that space. It's a really interesting point because I do agree. And you mentioned some companies that are on the application layer, whether that's Cursor, Windsor, Harvey.

16:45These are all companies that we've heard of that have broken out and shown some level of not only scale, but durability and distribution. I think distribution is very important. But one thing that I did here, and I want to test this a little bit. There was another investor that said the one difference between now and the enterprise SaaS world is things like coding have been effectively commoditized. and become at a pace where you can actually vibe code something over a course of two to four weeks and actually build something that is at parity with something that's already been funded. Does that hold water with you or do you believe that's a little bit overblown as a concern?

17:23I think it's a real concern. I think that is what distinguishes great products from an amalgamation of features that you can kind of pull together. And so when I think about like, what are the most interesting things that we're going to see on the application side, I think they're going to be much deeper than like a tool that does X that is pretty shallow in terms of what its capabilities are, right? And I think that the best companies are not the combination of like a bunch of kind of a concrete feature set. It's sort of how everything kind of works together and the depth of thought around like what the end users need.

18:01And I actually think to some degree, it's like, let's assume a world where a lot of companies can build their own custom solutions. Like what then? Like, is there the types of products then that exist in that world might look like radically different than what we saw in the SaaS world? Right. Now, going to kind of the macro for a second and thinking through like this existential potential threat to the average seed investor. returning. Again, we should be careful using the word average because average in venture is not very good. So you have to be the beneficiary fairly consistently of the power law to be able to produce the type of returns.

18:36But let's say the list of environmental characteristics that were in place six years ago are no longer here. The up and to the right for everything, the rising tide lifts all boats. It seemed like any seed fund that was investing could do fairly well given there were quick markups. And I do think some of that exists within AI. But given some of these symptoms that have emerged with the megafonds, YC, that could be in Kruger and along with the rising competition, what do seed funds do in today's environment where there is competition and you have some of these symptoms that have emerged with YC, the megafond?

19:13How do you thrive as a seed manager? And where are those particular points of inefficiency maybe? Yeah, I'm a big golf fan. And so a deep cut analogy, when this golfer Rory McIlroy used to answer all these questions around like all the challenges going on in the PGA Tour and some of the rule changes they had, one of the things he said was just got to play better. And so to some degree, I think the answer is like seed managers just have to do a better job, which have to invest better. And like, that doesn't really mean anything, except that the market's gotten more competitive. And, you know, this is supposed to be hard.

19:50And that's the nature of the game. So to some degree, I think you just have to invest better. Now, what are some opportunities to do that? One, I think that AI is coming for our industry in a pretty meaningful way in terms of how we operate. If you think about the activities of a venture firm, there's a lot of activities that could be automated, and there's a lot of data exhaust that we're not taking advantage of, right? And so in my second post, I talked about that as not a, it's not the answer. It's a sustaining innovation. If you recall, I have to think about how Clay Christian talks about that.

20:24You kind of have to do it in order to keep pace, but it's not going to completely change the game. But like the technology is there and there's a lot of opportunity. And so I feel like that's going to be really important. I think the other is seed investors. When you go back six years ago or so, like where everybody got into trouble is everybody's investing in the same kind of company. I remember Sam Lesson, I think, had this post about how it's the era of the factory model of venture capital. And it's a factory model because you're basically a supplier. you're just a piece of the supply chain.

20:55You're trying to figure out what the Series A and Series B investors like. And you just invest in those companies and you supply the downstream funders, and then you'll get a great markup and things will be great. And I just don't think that works. I think you got to be way weirder in terms of the kinds of things that you invest in, or you're going to be stuck in the white hot center and that gets priced to perfection. And so maybe that's fine. And you're just going to be able to compete really successfully in the white hot center, paying a high price with proven founders or proven opportunities, or you got to be willing to like really go on the edges, invest in stuff that's really unusual and be wrecked, which is where the skill I think really comes into.

21:37There's so much to unpack on this. And a lot of people wouldn't care to admit it, but some of the folks that did raise funds in 2016, 17, 18, a lot of the consideration of what to invest in was what would be considered attractive for the next line of investors to which you can get a markup, maybe multiple markets and maybe in bull markets that helps from the perspective of being able to raise that next fund. When you have really shiny marks relative to your peers, I think the end game of when those companies exit, oftentimes that has shown that doesn't actually work fairly consistently. You have to be finding things that are before it's obvious.

22:17And I do think one of the challenges that's been brought up more recently from folks is YC, for example, is something that demands a certain valuation because it's considered part of this kind of factory of like, this is how we work. A lot of the AI application companies, given how hot AI is, and if you look at the numbers of an AI company valuation versus a non-AI, the gap is widening by the day from C to late stage. So then when you think about this concept of, when I think about classic VC, and I'm going back 70s 80s 90s it was always kind of doing things that people thought were weird or off the beaten path but it was somebody that had some level of a prescient understanding of what might happen and a belief in an individual before it became obvious now things i there was a tweet out there where somebody said well if you don't have at least two two million dollars in run rate within 10 days, it's not interesting, which is antithetical to it.

23:16So talk a little bit about this classic VC model in today's world, given that a lot of these things feel like they're moving toward or at least we're training entrepreneurs to be more consensus driven from the get go. Yeah, it's funny. So the way I described it, I think we'll get to your question. And this was in my third post is there's emerged essentially like two different worldviews in terms of how VCs attack the market. There is the classic worldview, which is the goal is to invest in the unproven, right? Find founders who are working in the weird areas and try to invest before things take hold.

23:50And that's the mode through which most VCs have historically operated. The second, though, is a different worldview, which I've called it the super compounded worldview, you can call it whatever you want. And the idea here is that the main inefficiency is actually people underestimate the best companies. And so the name of the game is to invest in the thing that is working and do so at any price, because ultimately, the best companies are even better than you expect, right? And I think that for a lot of reasons that we already talked about, that worldview has really has sort of dominated actually in the last few years.

24:26And so I think that we have these two worldviews at work. And so that results in a real narrowing in terms of the types of companies that people invested because the Series A, the Series B investor, a lot more capital has gone into the market over the last few years, but it's gone into a very small number of companies, right? And it tends to be these companies that have a certain profile. It enables them to grow at a particular rate very quickly. And everything outside of that white hot center kind of gets left behind. And so then that creates an incentive for the earlier stage investors to say like, well, in order for me to survive and to get the markets I'm looking for, it really has to fit whatever that really narrow set of companies looks like.

25:09And so that's where I'm going to hunt, right? And so it becomes this like weird recursive thing where everybody's kind of trying to invest in the same kind of company, just like one step earlier. And I think that to some degree, there are gonna be some really good, great companies who come out of that. But I think that what used to be like a very narrow edge of potentially interesting companies that that missed that gets much, much broader, but there isn't really a capital market for these businesses downstream. And so I think that my bet is that things are going to rotate back towards more classic venture behavior because there is a failure mode to this super compounder strategy, right?