The Great Sobriety for Venture Investing, Where To Start with AI, & Undeniable Data

Let’s synthesize some lessons as the venture world is facing some harsh realities. We’ll also consider a framework for adopting AI, and review some data behind some crucial challenges we face.

Edition #10 of Implications.

• This edition explores forecasts and implications around: (1) some tough yet candid observations on the current state of venture capital and how great products can be salvaged from doomed companies, (2) a framework for adopting AI in your team and company, and (3) some surprises at the end, as always.

• If you’re new, here’s the rundown on what to expect. This ~monthly analysis is written for founders + investors I work with, colleagues, and a small group of subscribers. I aim for quality and provocation vs. frequency and trendiness. My goal is to ignite discussion and lay kindling for feedback and connecting dots.

• If you missed the big annual analysis or more recent editions of Implications, check out recent analysis and archives here. A few highlights include why humanity is becoming increasingly intolerant of friction, and what we need to do about it; the benefits of collapsing the talent stack, and 12 realizations I’ve had while running! OK, now let’s dive in…

The hard lessons learned from “the great incineration of capital,” a retrospective of the last decade of Venture Capital and how great products can be liberated from poorly structured companies.

I love supporting founders and bold ideas as an angel investor, and I have spent my career at the intersection of technology, business, and design. I have also benefited from VCs as an entrepreneur (Behance raised ~$6.5M as a break-even business after 5 years of bootstrapping from USV, and several angels I admired) and as an angel investor myself. However, in the years since I have become skeptical of the explosion of venture capital funds in the years since, the surging popularity of becoming a VC, and the impact that all of this excess capital will have on the ideas, products, and new ventures they claim to nurture. I also don’t think we’ve fully internalized the implications.

• Bubbles typically have a sobering moment. It first really hit me in 2021 when I found myself being pitched on both a new company and a new fund simultaneously during a call with a founder. He was starting a company and a fund at the same time. I had a visceral reaction, one of those “this is not going to end well” type feelings. It sobered me up in an instant, and I started to take perspective on the growing number of “solo capitalists” in my network leading rounds without taking board seats, the surprising amounts of money they were raising, and my growing doubts that all of this would result in strong businesses with eventual liquidity beyond the capital raised. At this point, I became interested in the underlying dynamics. A few massively successful transformational companies - mostly those founded pre-2012 - had established the expectation of a pattern, but the circumstances were now different. In 2021, the valuations, talent environment, cost of user acquisition, competitive landscape, exploitable growth opportunities, and liquidity options, were all materially different. But Limited Partners (those who fund VCs) and the VCs themselves were still playing the game as if things hadn’t changed - my angel check frequency included. We were all a bit intoxicated.

• The fire of unreasonable valuations was fueled by many sources. What a perfect storm: A cohort of companies funded 7-10 years prior had breathtaking debuts - Uber, Pinterest, Square, Shopify, etc - and everyone gets enamored by venture capital (it is a hell of a lot easier to write a check than to build!). Limited Partners amp up their desire to invest in venture funds, and fight for allocations (that’s how they get accolades from their bosses!). General Partners of venture funds realize they can raise 2-3x more and get an equivalent bump in their salaries and long term upside. Most do. Tired entrepreneurs join or start VC firms, realizing they can make a massive salary via 2.5% management fees and still hope for upside via their 20%+ carry (all while taking a breather from building). And as more and more capital is raised, it needs to be put to work (for investors to get paid!). As a result, more companies get funded including more companies in increasingly crowded categories, companies with smart founders but weak ideas, companies with great ideas but weak founders, and the ludicrous “party rounds” where people just invested based on who else invested. When entire companies are founded to manage party rounds, you know to take caution. All along the way, the media celebrated the fundraises, even if they were at preempted over-the-top valuations. To make matters worse, as valuations went up via subsequent rounds (for all the same reasons), the venture funds were able to raise even MORE money from their limited partners using their impressive “marked-to-market” metrics. And limited partners were also looking smart via their marked-to-market “gains.” The gasoline on this roaring cyclical money fire was zero interest rates. When everyone feels like they’re winning, nearly everyone is going to lose. Or at least be in for a rude awakening. The sources of sobriety are now aplenty

• Sobriety source #1: Reduced liquidity options. First off, the early stage valuations of ~2010 (Pinterest was ~$5M at the seed, Uber was ~$7M or so if I remember correctly) are rarely seen today. So, exits for a $100k check are materially less for even the greatest outcomes. But lets talk about liquidity more generally: The public markets don’t seem to have much tolerance for companies losing lots of money despite their growth rates. As multiples for many industries have come back down, perhaps the premium will shift to solidly profitable and reliable incumbent companies with higher growth relative to their peers? And perhaps the startups that do go public will do so at “normal” multiples that don’t reward the behavior of trigger-happy investors and inflated valuations? Even when companies do go public, their lock-up periods are extensive (especially for VCs on boards). Liquidity is also harder via M&A. Companies are doing fewer acquisitions as they reduce expenses to weather uncertainty, secure innovative services via APIs and partnerships rather than needing to buy a new technology, and navigate an increasingly complicated regulatory landscape. Finally, as liquidity options crunch, talent will turnover to avoid getting “trampled by unicorns,” as I framed it in this 2017 piece. As a result of these dynamics, we’ll see materially fewer “return the fund” opportunities for quite a while (in my opinion).

• Sobriety source #2: AI as the next platform shift. Every wave of new companies that transforms their respective industries is fueled by a major platform or technology shift. The advent of the web did this. The smartphone and mobile applications did this. And there is no doubt that AI is our next wave. But does every new wave always necessarily favor start-ups, or might some shifts favor incumbents? AI is fueled by data (which is easier to leverage when you already have it). AI more effectively collapses workflows in the tools people already use. AI may solve enough problems in the interfaces people use today, rather than require people to switch applications to enjoy the benefits of AI. At least in certain sectors of consumer and enterprise technology, existing companies are in the best position to both reach and fulfill customer needs in the age of AI. Of course, there will be many exciting exceptions. The world will need new developer and security tools for the age of AI. Certain industries like litigation or anomaly detection and forecasting can be reimagined. But I am most excited about AI doing things that were only ever possible working across many tools - often with very burdensome and manual processes. As my friend Aaron Levie, founder and CEO of Box, likes to say, “The exciting thing about AI startups right now is that most are solving problems we could never do with software before. The battlefield is not merely startups vs. incumbents, but entirely new markets emerging that wouldn’t have existed without AI.”

• Lesson #1: Financing is a tactic, not a goal. As I think about the implications of the new world of capital, I am most excited about the potential of very sober start-ups. We will see more startups bootstrap themselves longer, monetize sooner, and pressure test their business plan in ways that will prioritize product-led growth. Financing will become more tactical, and less of an ego-driven focal point. Somehow, over the last two decades, raising money for a new company became a badge of honor and a pursuit in and of itself. Somehow the ultimate form of validation in entrepreneurship was needing money. Nevertheless, the proxy for being a high potential company became a VC buying part of your company after a relatively quick round of diligence in the short time frame of a competitive market. Ultimately, the investors and employees of companies that over-raised capital just because they could will suffer the consequences.

• Lesson #2: Great venture investing is about focus, discipline, long-term greed, and having a specific superpower that you stick with. Very focused investors will stomach the volatility and thrive. There are a small number of supremely focused funds with a tight network that essentially get a “right of first refusal” of sorts from seasoned and/or domain-specific entrepreneurs. Such investors will do well despite this environment. I am also bullish on a small number of solo GP funds with less than $100M with strong networks and a very tight thesis and specific superpower (like building a sales team, etc) - these investors have become brands of their own and will succeed if they stay focused. Corporate venture capital may also make a comeback, especially in the age of AI, as companies seek expertise and go-to-market support. Many corporate venture practices like NVIDIA and Salesforce, as well as our team at Adobe are starting to invest without any additional strings attached - simply to build partnerships with likeminded companies that we can actually materially help in some way. Finally, I love deep tech funds with a super tight focus and deep expertise in a particular area of tech.

• New opportunities will emerge from the remnants of the chaos. There are some phenomenal products in some of the companies that were overfunded and are haunted by past decisions. The valuations at which these companies raised capital set them on the wrong path - a path that fails to attract and reward critical talent, a path that incentivizes excess expenditure for growth at the expense of structuring a business to be profitable, and a path that optimizes for an exit rather than a thriving and self-sustaining business. Remarkable products must be liberated from poorly structured companies plagued by an ownership structure with all the wrong incentives for a product to drive an incredible and enduring company. Perhaps we will see more holding companies (new variations of companies like Constellation Software) emerge that provide frustrated investors a quick and graceful exit while bolstering the morale, stability, and upside of the teams behind great products?

Where to start with AI? If your team is intrigued by how AI could impact your marketing or company operations, here’s how to start.

The most common question I am asked by peers these days is, “how do I get my team started with all this AI stuff?” Whether your team is in finance, marketing, product development, or some form of research, consider this “4 P’s” (you’re welcome) framework for how to navigate the path ahead:

• Play: Novelty precedes utility in the tech world, and you want to encourage and allow your teams to play with new technology despite the risks. Give them access without expectations.

• Pilot: All great revolutions at work start with a pilot - one project that the team is encouraged to do “the new way.” Encourage your team to pick a project - perhaps one thing a quarter, if not more - with the goal of learning from it. The more doubts you get from members of the status quo, the more chance you may be onto something at this early stage - so find a champion and let them run with a pilot.

• Protect: Make sure that the pilot project has a different set of KPIs/objectives that don’t penalize the drivers. The goal should be learning, not revenue or conversion - this is how you incentivize experimentation.

• Provoke: Invite the tough questions from those that participate or watch the new play unfold. The culture must allow for people to question the ROI, the ethics, or the implications. This is how you learn and avoid expensive mistakes with innovation. Be willing to do things that upturn and disrupt norms; it’s always true that “anything you don’t want to do to your business someone else will be willing to do to your business.” And remember, true innovation is a business of exceptions - just because something has been tried many times before and didn’t work doesn’t mean it’s the wrong idea…

Ideas, Missives & Mentions

**Finally, here’s a set of ideas and worthwhile mentions (and stuff I want to keep out of web-scraper reach) intended for those I work with (free for founders in my portfolio, Adobe folks…ping me!) and a smaller group of subscribers. We’ll cover a few things that caught my eye and have stayed on my mind (including some data I’ve seen that got me pretty disappointed or fired up, or both), as well as my latest areas of interest as an angel investor. Subscriptions go toward organizations I support including the Cooper-Hewitt National Design Museum. Thanks again for following along, and to those who have reached out with ideas and feedback.