A great read Kyle, almost like a pre-mortem of the venture capital fund model. This also relates to your article "Dreaming of Dry Powder" that you wrote in early 2023. Based on thar article, I wrote The Three-Body Problem in Venture Capital:
"Key Takeaways: The incentives of the three key players in venture capital are diverging, $500B in unrealized gains are at risk of being marked down in the coming years, and venture deal terms are starting to look less founder friendly."
"The Three-Body Problem in Venture Capital:
- Founders: Seeking funding urgently before capital dries up.
- VCs: Sitting on 300 billion of dry powder, hesitant to deploy.
- LPs: Prioritizing cash preservation for high-yield, low-risk investments.
While “dry powder” is legally available capital, at the same time, LPs want to preserve cash as interest rates creep up. LPs have an incentive to slow down their capital calls knowing that (a) near risk-free investment returns are increasing, and (b) their investment portfolios are at risk of markdowns."
- Investor-Friendly Terms: While investor-friendly terms started to creep up in early 2023, an interesting thing happened in mid to late 2023: Down-rounds shot up to 25%+ of all rounds (at late stage it's even higher). This trend shows up in Carta's data and in Cooley's Q3 2023 Report (29% of all seed financings were down rounds).
- Slower Pace and Lower Valuations: Deal activity has also slowed, with seed-to-A graduation rates dropping significantly (sub 5% for the first 12 months and only up slightly for 2022 cohort). Although legal terms have seen minor adjustments, valuations have generally decreased compared to previous rounds.
- Near Future: These forces point towards two potential outcomes in 2024: significant term adjustments favoring investors or increased startup and fund closures.
That being said, CalPERS just deployed $4.5 billion in the first half of 2023, representing 15% of all capital invested in US VC firms and some of the largest amount of VC capital in its history.
But who received those funds?
> Commitments include $300 million to Lux Capital’s eighth fund, $500 million to Thrive Capital’s eighth fund, $400 million to a new Andreessen Horowitz fund, and $700 million across several General Catalyst funds.
Again, this was for H1 2023, and this doesn't count all of the other fund-of-funds coming into venture.
Very curious to see how all of this capital will shakeout in 2024~!
Elon Musk called out the fact that "We should have fewer people doing law and fewer people doing finance and more people making stuff". I think that a lot of people are also building software businesses because:
i) The barrier to entry is lower than building a capex intensive business (both from capital and complexity perspective)
ii) Software valuations have been hot and heavy so the promise of a sky-high exit is very alluring to MBA grads
iii) Lots of VCs / PE firms that specialize in SW investing / chasing the next big thing in "mission critical software" (aka demand is high)
A great read Kyle, almost like a pre-mortem of the venture capital fund model. This also relates to your article "Dreaming of Dry Powder" that you wrote in early 2023. Based on thar article, I wrote The Three-Body Problem in Venture Capital:
"Key Takeaways: The incentives of the three key players in venture capital are diverging, $500B in unrealized gains are at risk of being marked down in the coming years, and venture deal terms are starting to look less founder friendly."
"The Three-Body Problem in Venture Capital:
- Founders: Seeking funding urgently before capital dries up.
- VCs: Sitting on 300 billion of dry powder, hesitant to deploy.
- LPs: Prioritizing cash preservation for high-yield, low-risk investments.
While “dry powder” is legally available capital, at the same time, LPs want to preserve cash as interest rates creep up. LPs have an incentive to slow down their capital calls knowing that (a) near risk-free investment returns are increasing, and (b) their investment portfolios are at risk of markdowns."
(Source: https://lawofvc.substack.com/p/26-episode-three-body-problem-venture-capital)
Market Trends and Predictions:
- Investor-Friendly Terms: While investor-friendly terms started to creep up in early 2023, an interesting thing happened in mid to late 2023: Down-rounds shot up to 25%+ of all rounds (at late stage it's even higher). This trend shows up in Carta's data and in Cooley's Q3 2023 Report (29% of all seed financings were down rounds).
- Slower Pace and Lower Valuations: Deal activity has also slowed, with seed-to-A graduation rates dropping significantly (sub 5% for the first 12 months and only up slightly for 2022 cohort). Although legal terms have seen minor adjustments, valuations have generally decreased compared to previous rounds.
- Near Future: These forces point towards two potential outcomes in 2024: significant term adjustments favoring investors or increased startup and fund closures.
That being said, CalPERS just deployed $4.5 billion in the first half of 2023, representing 15% of all capital invested in US VC firms and some of the largest amount of VC capital in its history.
But who received those funds?
> Commitments include $300 million to Lux Capital’s eighth fund, $500 million to Thrive Capital’s eighth fund, $400 million to a new Andreessen Horowitz fund, and $700 million across several General Catalyst funds.
Again, this was for H1 2023, and this doesn't count all of the other fund-of-funds coming into venture.
Very curious to see how all of this capital will shakeout in 2024~!
Interesting read!
Elon Musk called out the fact that "We should have fewer people doing law and fewer people doing finance and more people making stuff". I think that a lot of people are also building software businesses because:
i) The barrier to entry is lower than building a capex intensive business (both from capital and complexity perspective)
ii) Software valuations have been hot and heavy so the promise of a sky-high exit is very alluring to MBA grads
iii) Lots of VCs / PE firms that specialize in SW investing / chasing the next big thing in "mission critical software" (aka demand is high)