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(Context: I'm a VC) Some great points in the post, but I also see a few additional dynamics at play: 1) The last 10 years have been great for VCs and startups

(Context: I'm a VC) Some great points in the post, but I also see a few additional dynamics at play: 1) The last 10 years have been great for VCs and startups, but now VCs are thinking about how to make their funds last longer. Two reasons for this: first, time diversification matters. If you think markets might go down even more, you don't want to deploy the rest of your fund quickly, you want to spread it out over a few years and get a good average cost basis. Second, there's a healthy fear among VCs that LP capital will be much harder to secure in the next 1-2 years. And you don't want to deploy the rest of your current fund in the next 6 months if you won't have a new fund ready to go for 18 months. 2) Most VCs (and founders) hate down rounds. So a lot of existing companies are stuck because they previously raised at $X valuation, and now the market price is $0.75X, and either the VC doesn't want to push for a down round or a founder won't accept it, or both. 3) Aaron mentions this in the blog post, but everyone is worried about downstream investors. Our fund is big enough to lead a seed round, but it can't put a dent in a Series A, so we depend on Series A investors eventually backing our seed companies. And Series A investors often depend on Series B investors to invest a lot in the next round. And so on. If the entire growth stage market grinds to a halt -- and it seems like it basically has -- then early stage investors start worrying about making new investments because there's way less downstream funding available. So even if a seed VC believes this is an amazing time to build a company and there are lots of great seed opportunities out there, they might still slow down investing a lot if they know their companies will need more funding and that funding doesn't seem to be there right now. 4) I've been a VC for about a decade, and the gap between VC and founder valuation expectations is greater than it's ever been during that time. 3 months ago, a median seed round was at $20m post, and a lot were at $25m-$30m post. Now I still see a lot of seed founders looking for $20m-$30m post, but a lot of VCs believe we should be back to 2020 valuations of $10m-$15m post. The gap between an expectation of, say, $13m post on one side and $25m post on the other side is huge, and lots of conversations never even begin because of that mismatch.

twoodfin 4y ago
2) Most VCs (and founders) hate down rounds. So a lot of existing companies are stuck because they previously raised at $X valuation, and now the market price is $0.75X, and either the VC doesn't want to push for a down round or a founder won't accept it, or both. They discussed this phenomenon at length on a recent Odd Lots podcast, and I can’t understand it as anything but a market inefficiency that some smart VC firm will eventually exploit. Values (and thus prices) go up and down. Putting your head in the sand about it can’t be a winning investment strategy.
- lpolovets 4y ago
  I agree, I think this is an inefficiency. But it's a tough one to correct because startups are a repeated game, and everyone's worried about upsetting people they'll have to keep playing with. I think the logic is "I like this company, but if I offer a down round then will I piss off their existing investors? Will those investors stop sharing good investment opportunities with me? ... Ah screw it, I'll just skip this down round and focus on other prospective investments." I think multi-stage investors are probably best-positioned to address this, since they are both new and existing investors in the companies they back, so they should be able to offer market price down rounds for companies that are still promising but unable to attract external capital.
  - singron 4y ago
    Down rounds are bad for employee morale too since it puts previously issued options below water. It's probably worth it to re-issue equity, but that's messy and a lot of companies don't do it.
    - icedchai 4y ago
      At a previous company all of the employees (there weren't many left) demanded options be repriced. They were. Unfortunately, they still were worthless when the company was "acquired" in a fire sale.
      - bombcar 4y ago
        Which is why nobody likes down rounds, as it's indicative of where everything is going (and so the music stops).
        icedchai 4y ago
        Yep. But when your startup is burning through cash and you're not going to make next month's payroll, you're pretty much force to accept whatever terms you're offered. (Assuming you're offered any.)
cynusx 4y ago
are these US or EU observations?
- cam0 4y ago
  He works at a US fund (www.susaventures.com/), so most likely US observations.
- lpolovets 4y ago
  US
akharris 4y ago
Your second point is the dynamic that makes the least sense to me. In public markets, if a stock is cheaper relative to future earnings, that makes it a better buy. In our corner of the world, the opposite often holds true. There should be a tipping point where greed beats ego, but have not yet figured out how to find it.
- lpolovets 4y ago
  I agree. The aversion to down rounds feels mostly psychological and overblown to me.
givemeethekeys 4y ago
As much as VCs and founders hate down rounds - if the public market has dropped in value by 50% for mostly macroeconomic reasons - isn't it fair to then suggest that properties on the private market should be similarly worth less? We all hate for our homes to be worth 10% less in 2023 compared to 2022, but it is what it is, no?
- gumby 4y ago
  The dilution is what makes it so much worse in the venture market than in the public markets.
- xmprt 4y ago
  When you raise funding at a startup, you're usually creating new shares which dilute old shares. If a seed round VC is able to get out with a 20% loss then they might be happy, but what will actually happen is that the seed round VC's 10% share turns into a 8% share AND they look like they've taken a loss because the 8% share is worth less. In growing markets, the 10% turning into 8% doesn't matter because it was 10% of a $1M company vs 8% of a $10M company. You're still richer (at least on paper) than you used to be.
- HWR_14 4y ago
  > We all hate for our homes to be worth 10% less in 2023 compared to 2022 Speak for yourself. If all property drops, I'm ecstatic. I'm not moving or withdrawing money with a HELOC. So lower property values just mean less taxes for me. I mean, sure, it also means I may be underwater, but who cares? And if I decide to move, that just means the delta between my current place and a new place is smaller in absolute terms. There is literally no benefit to most homeowners for the real estate market being higher.
  - throwawaytemp27 4y ago
    Not sure where you live, but where I’m from, an increase/decrease in home value affects your proportion of the overall property taxes but not the absolute amount. If everyone’s home goes down by 20% then everyone gets same tax bill.
beambot 4y ago
On (4), it looks like the median seed valuation is still hovering around $25M based on AngelList statistics: https://stack.angellist.com/valuations https://stack.angellist.com/valuations Part of the difficulty in parsing public versus private company valuations is due to the time constant: It takes a while for private companies to get desperate, whereas public companies have a real-time bead on investor sentiment.
- gkapur 4y ago
  Angellists data is flawed here—- you ideally want to look at seeds that are completely new or coming from sub $2 million pre-seeds. They include seed extensions, seed extension extensions, high priced note extension to seed rounds, etc. and when the market slows down you see a lot of extension rounds which pushes that number up but those are not really new seed rounds. There are a host of other way their data is flawed as well :) but that’s a much longer topic.
deleted 4y ago
[deleted]
pedalpete 4y ago
I've been trying to understand the medium-term implications of your first point for the market. My understanding is that if a VC raised a $1B fund, and the fund lasts for 10 years, the investments really need to be made in the first 5 years. If VCs are sitting on the sidelines now, AND making smaller investments, what happens in year 2 or 3 when they have to deploy those funds? Do you think deal sizes will get outrageously large because of too much money in the system? Will there be another rush to sign deals to deploy the capital? Does this get talked about by VCs? Am I completely misunderstanding how this will play out?
- junofan 4y ago
  Pro rata and follow-on I believe.
  - pedalpete 4y ago
    As in more $$ will go into follow-on companies rather than letting the bad bets die? Or we'll likely see more money going into follow-on rounds, inflating that end of the market? You could be right.
    - junofan 4y ago
      Oh, follow-on money goes to good bets, and you’d get more aggressive on terms. The good bets get money anyway. I don’t think there’d be much change. But who knows what ppl will do.
- SilverBirch 4y ago
  It's perfectly possible for funds to return the capital to investors and just say "Hey, we couldn't find anything to invest in at a good price, so we didn't", and that'll look better for them because their ROI will still be good. This is also likely to happen because big investors generally have their investments split between lots of asset classes by some ratio, so let's say for the sake of argument that Harvard's endowment is 30% equities, 30% private equity, 10% fixed income, and a mix of other stuff. If the value of their equities in the stock market fall through the floor that means their ratio is suddenly off, so they're going to need to rotate out of private equity and into equities.
lifeisstillgood 4y ago
What amazes me is the seed round at 10s of millions. I was amazed to find the YC puts in 150k to each start up. I think it was 6k per founder back in the day. Apart from companies wanting to build battery storage, what do people do with 20M of seed funding? I mean surely it is time to pivot to finding dozens of companies wanting to just be profitable and return a dividend. Fund enough (but like YC) and one or two will become unicorns just because? or am I dreaming
- Zaheer 4y ago
  "$10m-$15m post" actually refers to the valuation of the company rather than the investment amount. The investment amount is typically 10-20%. So a valuation of $10-15m would mean an investment of $1-1.5m
- stingraycharles 4y ago
  I say this as someone who isn’t very familiar with this world, but have also noticed this. I think it’s a perception hack: there are some expectations about how a series A startup operates (demonstrated product/market fit, starts entering the growth stage, etc), and investors/founders still want to invest in companies that show great potential according to them, but just aren’t there yet, and it’s undesirable to oversell the company / raise expectations too high. Hence the massive seed rounds, with equally massive bridge rounds, etc etc.
simonbarker87 4y ago
I’ve often heard the modern VC route described as a Ponzi scheme with the public market being the greatest of the fools, I don’t totally buy into the idea but your 3rd point really does highlight how close it all is to a Ponzi scheme. So much value is absorbed in the VC pipe than by the time a company IPOs the chance of retail investors seeing returns is minimal to none.
- drdrek 4y ago
  Think about it in this way: You want to open a wholesale food distribution business for restaurants in a Manhattan You want to make sure that enough restaurants will buy from you They want to make sure that enough costumers will buy from them The customers are going out less because of a downturn in the economy So you do not open our business because the stock market is down Is any business a ponzi scheme? P.S Saying that, there is research that buying at IPO is rarely a good idea: https://www.youtube.com/watch?v=2a7qhIpxv60 https://www.youtube.com/watch?v=2a7qhIpxv60
  - sooheon 4y ago
    If early capital thought they would get better risk adjusted returns holding on to companies, they wouldn't exit. When considering a trade, you have to ask yourself "what do I know about the future prospects of this asset that the other party doesn't?" For IPOs you can see how stacked this transaction is against the public.
    - SilverBirch 4y ago
      I don't think this is right. The reason VCs exit is simple, they're VCs. They exist to invest in start ups. Their job is to invest in high growth, high risk start ups, and the risk premium reflects that, they're a certain type of asset class. That's why people give them money. People don't give money to VCs to buy Walmart stock. If a VC thinks it can get a better risk adjusted return investing in Walmart then they're not a VC. Why would a limited partner want the VC parking their cash in an established business? They already have allocated their capital amongst different investments including VCs to get the mix of investments they want. So the right thing to do is as the company matures and risk drops, they exit their investment. If the company still offers good risk free returns, well then the LPs can buy the stock, or their hedge fund investments will buy the stock. But the fundamental issue is if VCs stay in companies beyond a reasonable point then they're not doing their job.
frognumber 4y ago
(Context: I'm a successful serial entrepreneur, but never on the fundraising side) My experience is that the best investment opportunities are counter-cyclical. During a down economy, talent is cheap. Competition is low. It's easy to build a growth business which explodes when the economy enters a growth stage. It's also cheaper, more focused, and more efficient to have 5 people work for 5 years than 100 people for 1 year. 5-20 people is sort of optimal. That requires (more) patient capital, and longer times to IPOs, but has higher ROI. I think I could build any of several successful businesses with a smaller investment -- on the order of $5-10M -- sustained over a longer period (optimally, around $1-2M/year over 5 years). I don't think I'd want or need series B or C funding. That can accelerate things, which is helpful if I'm competing aggressively against five companies, and it's first to grab the market, but it makes companies a lot less lean, focused, and aligned as well. It also dilutes equity a lot, for everyone. Stock options have a reputation for being worthless, and when you run the numbers, that's generally true for anyone beyond the founders. Do you know if there are investors who can handle this type of structure? Or what constraints there are to having these kinds of investments? I understand the current time windows that a VC fund is open, but it's odd to me that there aren't more diverse types of funding available. Do you know why people haven't set up VC funds with other structures? It seems like a major inefficiency and friction....
- karterk 4y ago
  Have you looked at TinySeed? But they don't operate at a Series A scale in terms of cash deployed per investment. I suspect that the power law of returns in VC model requires really large outsized returns that cannot be achieved Without an all or nothing model.
  - frognumber 4y ago
    Outsized returns can be generated, just in due course. Blowing $500M is great for building an Amazon or an Uber -- if you require a lot of hardware or logistics. It's useful in a 4-way rat race where it's first-past-the-goalpost. I tend to prefer deep tech, where I build something hard (or relatively hard) that's never been built. A company like Bose has $3.2B in annual revenues, 58 years after founding, and I believe they've never raised external capital. That's because they have a big pile of unique technology. Contrary to their image, they do a lot of work which is not speakers (and which you've likely never heard of), from architectural acoustics to government. TinySeed looks to fund small, niche SaaS companies, mostly. Most of the stuff they fund, more or less anyone with SWE background could build. For developing hard tech, I'd pick $10M and 10 years over $200M and 2 years, any day of the week.
leroman 4y ago
Am I correct to understand that VCs get the same share of the pie, now, that the valuations are lower? So the valuation changes, the amount the VC puts in changed but not the % VCs get from the deal? This seems that the founders get the short end of the stick, no?

twoodfin 4y ago

2) Most VCs (and founders) hate down rounds. So a lot of existing companies are stuck because they previously raised at $X valuation, and now the market price is $0.75X, and either the VC doesn't want to push for a down round or a founder won't accept it, or both. They discussed this phenomenon at length on a recent Odd Lots podcast, and I can’t understand it as anything but a market inefficiency that some smart VC firm will eventually exploit. Values (and thus prices) go up and down. Putting your head in the sand about it can’t be a winning investment strategy.

lpolovets 4y ago
I agree, I think this is an inefficiency. But it's a tough one to correct because startups are a repeated game, and everyone's worried about upsetting people they'll have to keep playing with. I think the logic is "I like this company, but if I offer a down round then will I piss off their existing investors? Will those investors stop sharing good investment opportunities with me? ... Ah screw it, I'll just skip this down round and focus on other prospective investments." I think multi-stage investors are probably best-positioned to address this, since they are both new and existing investors in the companies they back, so they should be able to offer market price down rounds for companies that are still promising but unable to attract external capital.
- singron 4y ago
  Down rounds are bad for employee morale too since it puts previously issued options below water. It's probably worth it to re-issue equity, but that's messy and a lot of companies don't do it.
  - icedchai 4y ago
    At a previous company all of the employees (there weren't many left) demanded options be repriced. They were. Unfortunately, they still were worthless when the company was "acquired" in a fire sale.
    - bombcar 4y ago
      Which is why nobody likes down rounds, as it's indicative of where everything is going (and so the music stops).
      - icedchai 4y ago
        Yep. But when your startup is burning through cash and you're not going to make next month's payroll, you're pretty much force to accept whatever terms you're offered. (Assuming you're offered any.)

cynusx 4y ago

are these US or EU observations?

cam0 4y ago
He works at a US fund (www.susaventures.com/), so most likely US observations.
lpolovets 4y ago
US

akharris 4y ago

Your second point is the dynamic that makes the least sense to me. In public markets, if a stock is cheaper relative to future earnings, that makes it a better buy. In our corner of the world, the opposite often holds true. There should be a tipping point where greed beats ego, but have not yet figured out how to find it.

lpolovets 4y ago
I agree. The aversion to down rounds feels mostly psychological and overblown to me.

givemeethekeys 4y ago

As much as VCs and founders hate down rounds - if the public market has dropped in value by 50% for mostly macroeconomic reasons - isn't it fair to then suggest that properties on the private market should be similarly worth less? We all hate for our homes to be worth 10% less in 2023 compared to 2022, but it is what it is, no?

gumby 4y ago
The dilution is what makes it so much worse in the venture market than in the public markets.
xmprt 4y ago
When you raise funding at a startup, you're usually creating new shares which dilute old shares. If a seed round VC is able to get out with a 20% loss then they might be happy, but what will actually happen is that the seed round VC's 10% share turns into a 8% share AND they look like they've taken a loss because the 8% share is worth less. In growing markets, the 10% turning into 8% doesn't matter because it was 10% of a $1M company vs 8% of a $10M company. You're still richer (at least on paper) than you used to be.
HWR_14 4y ago
> We all hate for our homes to be worth 10% less in 2023 compared to 2022 Speak for yourself. If all property drops, I'm ecstatic. I'm not moving or withdrawing money with a HELOC. So lower property values just mean less taxes for me. I mean, sure, it also means I may be underwater, but who cares? And if I decide to move, that just means the delta between my current place and a new place is smaller in absolute terms. There is literally no benefit to most homeowners for the real estate market being higher.
- throwawaytemp27 4y ago
  Not sure where you live, but where I’m from, an increase/decrease in home value affects your proportion of the overall property taxes but not the absolute amount. If everyone’s home goes down by 20% then everyone gets same tax bill.

beambot 4y ago

On (4), it looks like the median seed valuation is still hovering around $25M based on AngelList statistics: https://stack.angellist.com/valuations https://stack.angellist.com/valuations Part of the difficulty in parsing public versus private company valuations is due to the time constant: It takes a while for private companies to get desperate, whereas public companies have a real-time bead on investor sentiment.

gkapur 4y ago
Angellists data is flawed here—- you ideally want to look at seeds that are completely new or coming from sub $2 million pre-seeds. They include seed extensions, seed extension extensions, high priced note extension to seed rounds, etc. and when the market slows down you see a lot of extension rounds which pushes that number up but those are not really new seed rounds. There are a host of other way their data is flawed as well :) but that’s a much longer topic.

deleted 4y ago

[deleted]

pedalpete 4y ago

I've been trying to understand the medium-term implications of your first point for the market. My understanding is that if a VC raised a $1B fund, and the fund lasts for 10 years, the investments really need to be made in the first 5 years. If VCs are sitting on the sidelines now, AND making smaller investments, what happens in year 2 or 3 when they have to deploy those funds? Do you think deal sizes will get outrageously large because of too much money in the system? Will there be another rush to sign deals to deploy the capital? Does this get talked about by VCs? Am I completely misunderstanding how this will play out?

junofan 4y ago
Pro rata and follow-on I believe.
- pedalpete 4y ago
  As in more $$ will go into follow-on companies rather than letting the bad bets die? Or we'll likely see more money going into follow-on rounds, inflating that end of the market? You could be right.
  - junofan 4y ago
    Oh, follow-on money goes to good bets, and you’d get more aggressive on terms. The good bets get money anyway. I don’t think there’d be much change. But who knows what ppl will do.
SilverBirch 4y ago
It's perfectly possible for funds to return the capital to investors and just say "Hey, we couldn't find anything to invest in at a good price, so we didn't", and that'll look better for them because their ROI will still be good. This is also likely to happen because big investors generally have their investments split between lots of asset classes by some ratio, so let's say for the sake of argument that Harvard's endowment is 30% equities, 30% private equity, 10% fixed income, and a mix of other stuff. If the value of their equities in the stock market fall through the floor that means their ratio is suddenly off, so they're going to need to rotate out of private equity and into equities.

lifeisstillgood 4y ago

What amazes me is the seed round at 10s of millions. I was amazed to find the YC puts in 150k to each start up. I think it was 6k per founder back in the day. Apart from companies wanting to build battery storage, what do people do with 20M of seed funding? I mean surely it is time to pivot to finding dozens of companies wanting to just be profitable and return a dividend. Fund enough (but like YC) and one or two will become unicorns just because? or am I dreaming

Zaheer 4y ago
"$10m-$15m post" actually refers to the valuation of the company rather than the investment amount. The investment amount is typically 10-20%. So a valuation of $10-15m would mean an investment of $1-1.5m
stingraycharles 4y ago
I say this as someone who isn’t very familiar with this world, but have also noticed this. I think it’s a perception hack: there are some expectations about how a series A startup operates (demonstrated product/market fit, starts entering the growth stage, etc), and investors/founders still want to invest in companies that show great potential according to them, but just aren’t there yet, and it’s undesirable to oversell the company / raise expectations too high. Hence the massive seed rounds, with equally massive bridge rounds, etc etc.

simonbarker87 4y ago

I’ve often heard the modern VC route described as a Ponzi scheme with the public market being the greatest of the fools, I don’t totally buy into the idea but your 3rd point really does highlight how close it all is to a Ponzi scheme. So much value is absorbed in the VC pipe than by the time a company IPOs the chance of retail investors seeing returns is minimal to none.

drdrek 4y ago
Think about it in this way: You want to open a wholesale food distribution business for restaurants in a Manhattan You want to make sure that enough restaurants will buy from you They want to make sure that enough costumers will buy from them The customers are going out less because of a downturn in the economy So you do not open our business because the stock market is down Is any business a ponzi scheme? P.S Saying that, there is research that buying at IPO is rarely a good idea: https://www.youtube.com/watch?v=2a7qhIpxv60 https://www.youtube.com/watch?v=2a7qhIpxv60
- sooheon 4y ago
  If early capital thought they would get better risk adjusted returns holding on to companies, they wouldn't exit. When considering a trade, you have to ask yourself "what do I know about the future prospects of this asset that the other party doesn't?" For IPOs you can see how stacked this transaction is against the public.
  - SilverBirch 4y ago
    I don't think this is right. The reason VCs exit is simple, they're VCs. They exist to invest in start ups. Their job is to invest in high growth, high risk start ups, and the risk premium reflects that, they're a certain type of asset class. That's why people give them money. People don't give money to VCs to buy Walmart stock. If a VC thinks it can get a better risk adjusted return investing in Walmart then they're not a VC. Why would a limited partner want the VC parking their cash in an established business? They already have allocated their capital amongst different investments including VCs to get the mix of investments they want. So the right thing to do is as the company matures and risk drops, they exit their investment. If the company still offers good risk free returns, well then the LPs can buy the stock, or their hedge fund investments will buy the stock. But the fundamental issue is if VCs stay in companies beyond a reasonable point then they're not doing their job.

frognumber 4y ago

(Context: I'm a successful serial entrepreneur, but never on the fundraising side) My experience is that the best investment opportunities are counter-cyclical. During a down economy, talent is cheap. Competition is low. It's easy to build a growth business which explodes when the economy enters a growth stage. It's also cheaper, more focused, and more efficient to have 5 people work for 5 years than 100 people for 1 year. 5-20 people is sort of optimal. That requires (more) patient capital, and longer times to IPOs, but has higher ROI. I think I could build any of several successful businesses with a smaller investment -- on the order of $5-10M -- sustained over a longer period (optimally, around $1-2M/year over 5 years). I don't think I'd want or need series B or C funding. That can accelerate things, which is helpful if I'm competing aggressively against five companies, and it's first to grab the market, but it makes companies a lot less lean, focused, and aligned as well. It also dilutes equity a lot, for everyone. Stock options have a reputation for being worthless, and when you run the numbers, that's generally true for anyone beyond the founders. Do you know if there are investors who can handle this type of structure? Or what constraints there are to having these kinds of investments? I understand the current time windows that a VC fund is open, but it's odd to me that there aren't more diverse types of funding available. Do you know why people haven't set up VC funds with other structures? It seems like a major inefficiency and friction....

karterk 4y ago
Have you looked at TinySeed? But they don't operate at a Series A scale in terms of cash deployed per investment. I suspect that the power law of returns in VC model requires really large outsized returns that cannot be achieved Without an all or nothing model.
- frognumber 4y ago
  Outsized returns can be generated, just in due course. Blowing $500M is great for building an Amazon or an Uber -- if you require a lot of hardware or logistics. It's useful in a 4-way rat race where it's first-past-the-goalpost. I tend to prefer deep tech, where I build something hard (or relatively hard) that's never been built. A company like Bose has $3.2B in annual revenues, 58 years after founding, and I believe they've never raised external capital. That's because they have a big pile of unique technology. Contrary to their image, they do a lot of work which is not speakers (and which you've likely never heard of), from architectural acoustics to government. TinySeed looks to fund small, niche SaaS companies, mostly. Most of the stuff they fund, more or less anyone with SWE background could build. For developing hard tech, I'd pick $10M and 10 years over $200M and 2 years, any day of the week.

leroman 4y ago

Am I correct to understand that VCs get the same share of the pie, now, that the valuations are lower? So the valuation changes, the amount the VC puts in changed but not the % VCs get from the deal? This seems that the founders get the short end of the stick, no?