Equidam's Dan Gray: venture capital is in stagflation — most mid-market firms are stuck in the dead zone

if you're there, can you hear me? How you doing? Longtime listener, first- time caller. Glad to be here. Yeah, great to have you. Uh can you take me through your Oh, actually first let's kick it off with just an introduction. H uh how uh uh who are you? What do you do? Break it down for everyone. Sure.

Yeah, I'm uh you know my my kind of day job is head of insights at Equidam. We're a startup valuation platform and that's kind of the perspective from which I come at all of this. Yep. I think what I'm what I'm most known for is like long walls of text on Twitter about the venture industry.

Uh and what was the most recent long wall of text that you put out? Uh yeah, that was kind of like a summary of the like the la last year or so of of observations. Um kind like not a very venture capital and ailing asset class addressing a lot of the challenges that we've seen. Yes.

But it moves towards like solutions, you know, better practices, some ideas for how the industry can evolve so everybody comes out of it better, you know, LPs, founders, GPS. So what are the key cracks? Why is venture capital ailing? What are the key problems that you're seeing? What are the indicators?

What are the metrics that you're tracking? Because a lot of people have been saying, "We're so back. It looks really good. There's big funds. Everyone's doing well. Everyone's making money. " It seems like it. So, this was kind of an odd take to see, but open to hear the argument obviously. Yeah.

I think kind of what we see at the moment, uh, if you look very broad, big picture is like stagflation. Mhm. There is, I would say, less activity than before, but prices in concentrated areas are much higher. Mhm. And for a lot of people, that's a very bad thing.

You know, if you're uh a founders fund and you can win on merit and get into any deal you want, you're doing fine at the moment, that's okay. If you're Andre Horowitz and you have the scale to to buy into any deal, you're also doing fine.

But a lot of my writing is is actually really aimed at like the middle of the market. GPS who you know could be doing better maybe if they if like better practices were more accessible to them or if the market was a bit more stable.

And similarly LPS who have a difficult time picking you know if they're not already in like the founders funds and USVS um how they can be guided towards better decisions and better returns.

So yeah, uh is this just affecting new managers who raised funds maybe during ZERP or are you seeing cracks in uh kind of the the legacy firms that have dropped out of the public eye? They're not as competitive, but they've been in the game for a decade. They have uh kind of an institutional structure.

Maybe they're not raising multi-billion dollar funds, but they have a model where it's like, "Yeah, $300 million fund. Every two years we deploy it. It's great business. all the partners are going to retire wealthy. Um are is there risk for that type of uh mid-market VC firm?

I think the the ones that are struggling the most at the moment are perhaps the ones that like haven't evolved as quickly as the market has shifted in the last year. So we've seen this this much talked about bifocation into like what I call venture banks. So like Andre and Horowits and Thrives etc.

and the kind of traditional model of VC which is you know contrarian investing bit more disciplined you could say on on that front there's a few people a few funds uh kind of stuck in the middle you know and they're a midsize series A firm who's still trying to invest in AI and they're having a very difficult time right now so you kind of have to pick your lane a little bit these days and lean into the strengths of what those two different lanes offer did you ever read EV have uh Ever Randall's post on uh like the Tiger Global and the uh and the and like the squeezing between uh what was he calling it?

He had some great phrase for it uh playing different games. Why Tiger is eating your lunch and your deals.

It was kind of talking about how Tiger and the crossover investors came in and they were just commodity capital that you just show up with a deck and get a term sheet the same day and it was very much like venture bank uh versus the uh what uh how did he describe it?

He said the uh he described uh one of the funds as like JC Penney funds which is very uh rude is the dead zone.

So there's Tiffany and co which he said was like benchmark founders fund like the really like uh prestige sequoas of the world low velocity higher irr main advantages signaling building a board of directors but it's expensive capital then you have the Walmart which was Tiger Global higher velocity lower IRRa but they're built to to accept a lower IRRa although that didn't play out very well for Tiger specifically but in theory these venture banks are kind of playing in this Walmart category but the dead zone was the J C Penney where you're not super differentiated sending a really strong signal to the market that we have picked the winner they're going to the moon and so get in or get out but you're also not super founder friendly not taking a board seat just dumping cash in a company is that dynamic still real in your mind has it grown or has have things changed yeah I think it's very real it's definitely real and you can see that in a lot of the liquidity issues today so you have you know the big like venture banks let's call them yeah They're finding more opportunistic liquidity through through secondaries for like the the huge winners that they invest in who have the the strength of brand and the size uh to generate a lot of liquidity in that manner where other VCs would traditionally get liquidity.

IPOs and M&A we all know has been very slow. Mhm. And that that slowdown for a range of reasons, but it's part of because the industry became so bloated and confused for a while.

You know, hopefully as this this bifocation is better understood, those more traditional managers are like teeing up companies for exits uh in in a healthier way. You know, they better understand the kind of exit metrics you need. Yeah. As opposed to the the venture bank model.

Do we need to kind of re redefine these terms of venture capital?

Because it used to be there was like angel investors, then venture capitalists that would do series A's and maybe series B's and then there was growth equity, private equity, and then like yes, a hedge fund might take a large position in a late stage firm, but they weren't seen as VCs.

Now you can have a VC firm that I I'm pretty sure there's venture capital firms that have never invested in a company at less than a$1 billion dollar valuation because their whole business is maybe we buy secondary or we buy common or we do growth stage and we're really only trying to be along for the unicorn to a hundred billion dollar ride and we'll do that all day long because there's so little downside and the by the time we're investing the company has durable revenues is growing product market fit.

So, we're not even trying to underwrite the founder or their ability to explore the idea maze. We're just piling in. But, we still call that venture capital. And maybe that's is that a problem or do we need to think about the the market differently?

I think it it's definitely helpful to to think about it as a slightly separate beast. You know, venture capital in my mind is finding, you know, the non-conensus companies and then you you fund them through into like legibility into growth growth capital and ultimately to an exit. Mhm.

That's how you generate your liquid liquidity. The new game today is kind of like this financialized version of venture capital where it's not necessarily about like finding great companies and taking them to exit.

It's about like funding through the like the incremental milestones and hitting those incremental metrics to to raise bigger funds, you know, and you do that through pursuing TVPI in a way that like is slightly disconnected to generating value in the traditional sense.

You know, TVPI is a has slightly different drivers, you could say. Yeah. Do you think that part of the reclassification as somewhat other asset classes into venture capital is driven by a desire to uh mimic the fee structure of a traditional venture capital firm in other in other industries?

So I'm a I basically doing public markets investing and I might be able to get one and 10, but if I call myself a VC firm and I play a little bit differently, I get two and 20 or something like that. it. Do you think that the branding matters when VC firms go out to LPs and try and raise money? That's a good question.

I'm I'm not really sure about that to be honest. I mean, I I'd hope LPs were scrutinizing that a little bit more, but perhaps not. How uh what do you do you look at any data on the health of the sort of retail in the private markets, right? like the the everyday angel investor.

Are you seeing more or less activity today than in 2021, early 2022? Uh I would say quite a bit less, probably like a third less at the moment because so much attention is concentrated on AI and I think a lot of angels, frankly, have just resigned themselves. Like they're not going to get in on that game. Yeah.

Interesting. Yeah. I was thinking I I I was uh I was even going to consider doing a poll uh to anybody with an you know just a poll on X or whatever. But I think if you ask the average angel investor, would you sell your entire angel investing portfolio for 15 cents on the dollar today?

And I bet you that I bet you the honest answer is that like 90% of uh of people would because angel investing is this like weird dynamic where to me I I legitimately feel addicted to angel investing like it like it's it's a weird thing but and I and I joke about this right it's like all these kids you know these kids that grew up in San Francisco and their and their parents are addicted to angel investing you know just like refreshing their refreshing their email on the first of the month you know waiting waiting for waiting for the update.

Um, but it's but it's this interesting, you know, dynamic where it's honestly one of, you know, to me it's one of the most interesting ways to spend free time is just like meeting exciting founders, but at the same time liquidity timeline so longit even if you make money, it's like, well, I didn't get to enjoy that in my 30s.

Yeah. Like, yeah, totally.

And I have I have buddies that are that are towards, you know, the end of their careers or or maybe even retired that are that are basically like somebody recently said to me, I don't want to make net new angel investments because I don't want to deal with this when I'm like potentially in a retirement, you know, like potentially like, you know, retired to Hawaii, right?

I don't want to be worried about uh, you know, figuring out, oh, when, you know, when should I try to exit, you know, this position? Uh Dan, can you break down this idea that most venture capitalists don't understand risk management and um only 10% of venture firms are making it to fund four?

What do VCs get wrong about risk management? What does risk management even mean? I thought the whole point was to be risk on, swing for the fences, man. It's a that's a great question. It's a a real fundamental point as well.

I talk about like the importance of risk management in venture capital and people do give me a slightly crazy look like the point is risk. Yeah, but if you properly manage risk like in a systematic way, you can take more risky bets. Like that's kind of the point.

Like if you understand the maths of portfolio construction, how big your checks are going to be, you know, what the outcome is likely to be, how many you have to write, what maximizes your exposure to potential unicorns, you know, what what discipline across the whole portfolio looks like, you can take more risk on an individual investment basis.

And yeah. So what does uh what does a poorly riskmanaged fund look like? Is it is it just not building concentration in the winners, not leaving money in the fund for proata and followons to kind of ride the winners up as they become outsized winners.

I feel like that was something that we heard from like the last generation of managers. They got a $50 million fund.

Then everything got marked up in Zerp and all of a sudden they had to make these decisions on huge proata checks out of their main fund where there really was no new data about the company and they were still at a seed level. But some big firm had come in and preempted a series A or series B.

And so all of a sudden you can't do the normal thing of wow there's so much traction on this company. I need to really make sure my fund has a significant ownership because I did get a foothold in but I need to build that position. Is that what's going on or is there something else some another dynamic?

Yeah, that's a part of it. That's quite a big part of it. Um I think that like the fundamental thing is the having a right-sized initial portfolio. The number of investments that you make to begin with. Yeah, that should be diversified enough and you know the the average might be like 25 today. Maybe it should be 50.

Um how do you even calculate that? Is that based on like historical trends in like the number of unicorns or something like how are you how are you thinking about that? Yeah, exactly. There's there's great work done by a few people. Dave Mccclure from 500 Startups, he has an article on this.

He talks about you know a hundred startups should be the portfolio size for for a seed fund. Wow. Uh because of the the small percentage that eventually become unicorns or decacorns. Yeah. And you you fundamentally don't know to begin with which which ones are going to work out.

That's kind of the problem is VCs overconentrate. And of course, if you're, you know, I' I've spoken to some great GPS about this concept and they always push back because they have 15 companies and they're all doing great. And that's like fine, good for you. You're in the top 2%.

It's the other 98% that I'm kind of thinking about.

But is that really a way to get to like by definition the don't you to be in the top 2% don't you have to behave like the top 2% and just actually like consider it a skill issue and just make sure well if you're trying to if you're trying to get you know I can see the argument if you if you're trying to get past fund four which is like the milestone you need to have bangers in the first fund right like even if even if you're not necessarily even if your ownership is not amazing you need to be able to prove that you can get into winners at all to some degree.

And so I've seen that strategy play out fairly nicely where as long as you're in a handful, you know, just get showing that you can get in is kind of like key proof points even if you're not able to concentrate, you know, five plus% of your of your fund in a in a single company. Yeah.

Do you think do you think LPs are more willing to forgive on mistakes of portfolio construction not sizing into winners easier than missing winners and having like okay yeah you built the portfolio perfectly you got concentrated into your winners properly but you didn't have any of those really sexy companies in the portfolio.

Well, I'd like to think ultimately what matters is, you know, the the end multiple, the IRRa, the performance of the fund. And everyone, you know, the majority of of emerging managers come out swinging for the fences every single time. They want a 10x fund. And in doing so, they like are themselves boom or bust.

If they fail and it's less than returning capital, they have no room to learn. They can't improve for the next fund. You know, there's there's no step two. If they are a bit more conservative, a bit more diversified and they return like 2.

5 3x maybe they get a fund too and they learn and they can improve and earn concentration over time. Isn't there something beautiful about the fact that both startups exhibit a follow a power law and venture capital firms exhibit a power law?

Like there's a there's a kinship here that it's like, hey, we're all either going to be rich or poor here. There's no median outcome. You're not just a bank to me. uh you're not going to be around unless this works out. You're living under the power law just as much as I am as the entrepreneur.

I would disagree with that to be honest with you. I I I think it it's a better world for everybody if the VCs are more stable. Okay. You know, they they they are very powerful. They are boom and bust. They don't really have to be. They don't have to be interesting. Interesting. Well, yeah, this is great. This was great.

Thank you for coming on and sharing. Uh, next time you have a report, give us a heads up and uh, love to have you back on it. Yeah, we'll talk to you, Dan. This is great. Thanks so much. Uh, let's run through some, uh, timeline. Let's give some updates, whatever else is in the news. What else?

I've got an idea before we jump into the timeline. Should we talk about Figma? Of course. Figma tell us about Figma is the design tool of my dreams. It's a tool that that I have used for my entire career at this point. Think bigger, build faster. That's great. generic for that.

Um uh how you design, explore your ideas freely and iterate quickly. We should make we should make an actual like old school style radio ad uh for this. But um but anyways, Figma uh launched a bunch of new features last week at config. One of which is very cool.

They allow you to generate marketing uh various types of assets based off of your brand book. It's called Figma Buzz. Uh so exciting new feature from them alongside sites and and uh kind of the core uh you know design tools that you probably already use and love.

So go check out Figma Buzz and sites and thank you to Figma show. Uh should we talk about some timeline? Let's do it. Uh Jason Calcanis of the All-In podcast is uh is taking the movie industry to task. He says the movie industry is effing clueless. Make a $19 a month. All you can watch.

$10 uh plus $10 for each kid and $49 for a family of five. Watch the money. Pour in. He wants a subscription. Movies would be huge if you made it a season pass like the ski industry did with the epic pass. Show old movies too for bonus points. AMC will slash prices on Wednesday is the news by 50% starting in July.

The goal is to get more people in theaters between weekends. What's interesting is that I saw a separate article about how uh the modern instantiation of Movie Pass is wildly successful. Have you heard of this? The I think it's like Well, yeah. Apparently AMC has a subscription product already. They do.

I think the interesting thing that Jason called out is showing old movies. I think one of the challenges is that there's so few new movies coming out that people are genuinely, you know, wanting to get up and go see. Yep.

Uh, I don't know if old movies would do it, but um, they do re-releases all the time and they are available and I don't think they build as much hype because I I think there's some weird dynamic in the movie industry where like unless you see Billboard and the hype and like you have you're texting your voice.

I think I think it comes down to scarcity. The the they need to pull movies off of every off the internet entirely for a year and then just build it up and being like we're bringing it back. You know, the people, some people will be like, "Well, I have a DVD. I can watch it anytime.

" Good luck playing a DVD on your home entertainment system if you got it in the last 5 years. Not going to work. Um, anyway, staying with the All-In podcast. Chimath Polyhapatia says, "Not nearly enough. People are talking about the implications of Clara rolling back some of their AI bets.

Not knowing any of the details, I can guess why. Replacing determinism of h or humans with probabilistic code is fraught with edge cases and require new ways of software development and process engineering that aren't well solved.

The implications to an entire generation of AI apps will be as severe uh will be severe as more companies come to terms with the difficulty in getting products to work reliably in production with AI in the loop. Customer service may be the first funeral signpost.

The result will be that many startups need to pivot to simply use AI for narrow use cases and otherwise act deterministically. So what will what will so what have people funded then? An AI company? No, not really. Just a really overpriced SAS company at AI valuations. Interesting. What do you think?

Uh I mean I thought the conversation with OWN yesterday from Intercom was super insightful, right? they are incredibly well positioned to deliver AI to CX teams and and unlock the power of it, but they're not saying there he he wasn't coming on and saying 99% of tickets are solved by AI today.

He believes that, you know, we can get there over time. And he his hot take was that, you know, AI was, you know, better than humans already at a lot of things, right? It stays on script. It it uh doesn't get tired. It doesn't get short. it's not temperamental.

All these things that um you know end up creating a better customer experience once the quality is at a certain point. This idea that like we we overestimate what can be done in a year, underestimate what can be done in a decade. You got superhuman autocomplete for every single one of your customer service agents.

You got much better ways to navigate a knowledge base effectively and just serve up a better Google search, use it as a knowledge engine. And so that should drive those. But, uh, trying to go full CLA mode and saying, you know, we're not hiring anyone. We're going to be a oneperson company. Probably a little aggressive.

Yeah. Anyway, Obby Schiffman, uh, founder of friend. com says, I met my investors LPs and realized I'm just working for college endowments and f family offices. Activate golden retriever. Yeah, you are. And it's good. It's an opportunity. It's an amazing blessing.

I mean, we heard about this from Andrew Reid talking about uh when he was pitching Dylan Field at Figma, brought him into the the Brown conference room and said, "Hey, like we work for Brown. You have an opportunity to run it up for Brown. " Yeah. You have an opportunity to run it up. Run it up to go long brown.

Exactly. And it's not just college endowments. It's it's teacher pension funds. It's, you know, you're supporting firefighters, all these things. So, uh you're supporting you're you're helping big oil, right?

I mean, that is that is part of the beauty of like the intertwined financial system is that uh losses are born across the entire uh economy so that any one company that blows up doesn't destroy everyone's pension.

Um and but but when there's big winners, everyone kind of benefits if you have a pension or you go to one of these schools like their endowment is enriched and they do more research and science and all sorts of stuff. And so you you have kind of a uh um uh I mean it's just it's diversification, right?

It's just diversification. And so, uh, like you you don't hear as many of those stories about, uh, an individual main street investor that lost all their money on a risky startup bet because angel investing is while addictive, it is for, um, high net worth individuals and accredited investors only.

But they still have exposure to the venture markets through LPs. Yeah. Uh, Prime Video has renewed Beast games for not one but two more seasons. Y'all are not ready for the big stuff. We have plans, says Mr. Beast. Very interesting. This was one that was like hotly debated about whether whether whether it was good.

It's hard to track because you can't just you can't just look at the YouTube metrics to understand if Beast Games was truly successful for Amazon Prime. But we have the data now, season 2 and season 3 confirmed. They probably wouldn't have done that if it underperformed.

So interesting watching a YouTuber transition to mainstream media or you know bigger platforms. I mean Amazon Prime's new media but still you know a a huge company, major network.

He's clearly worked out a fantastic deal and we've seen a bunch of this and it feels like it's more of a increasingly uh social media is a proving ground for Hollywood. Um talk about Pat McAfee, what he did with his podcast, took it to ESPN eventually.

Um I think we're going to be seeing a lot more of this as people uh build uh independently and then ultimately leverage the distribution that comes from something like Amazon Prime. So congrats to Jimmy. Uh we should have on the show. Daltton Caldwell says the S&P 500 now has three YC companies.

Door Dash, Airbnb, and Coinbase. Let's hear it for YC. Can we get the Can we get a size gong or some clapping or something? Just amazing. Congratulations. I can't wait to go back to the next demo day. Yeah, me either.

Uh it is it is actually crazy how how big that YC has done this because no other incubator is even close, right? And I'm excited for the update in in 2055. The S&P 500 is now 60% Y Combinator companies for sure. Uh certainly uh if you expand that to YC founders running companies probably says 497 to go. 497 to go.

PJ I like it on a conquest. Good job. Uh and all are consumer tech. Yeah, right. Everybody says build B2B SAS until you see some of the biggest outcomes. Just wait. I mean a couple of those payroll companies will be in the S&P 500 pretty soon, I'm pretty sure.

Anyway, all three of uh Aiden says, "Uber would be a lot cooler if it was called American Express. " I I I just love this guy. Seven likes. Low tam. But low tam banger. Yeah.

He also had another post that we didn't get to yesterday that was like uh if if uh if the airlines calling your name personally as you board the flight, it's basically like flying private. I thought that was funny. Anyway, shout out to Aiden. Great great programmer, great hacker.

Uh Airbnb is launching uh they're unveiling their next chapter. This is going live today. I don't actually have the update, but Russi found mode. So, they're launching new services, businesses. Interesting. Uh there's a redesigned app. So, remember they condensed a bunch of launches into one. Yep.

uh expanding the experiences for a while, expanding beyond home stays and uh I guess they're going to invest a quarter of a billion dollars into this new sort of business line where you can like it's it seems like an extension of their kind of experiences product. Sure.

Um but uh anyways, hopefully they can um uh hopefully they not can hopefully they don't crush under the weight of competition with Wander. Yeah, honestly that's that's my only hope series founder mode CEO love him but they're going to be feeling the heat. They're going to be feeling the heat from Wander for sure.

Uh Adam D'Angelo said at Quora, we recently tested switching from Zoom to Google Meet for a week. Google Meet is better in many small ways, but bit worse in one big way. Audio quality, particularly background audio noise cancellation, echoing that kills it. So, we're staying on Zoom. This is funny.

just like hey I did this uh AV test and we're sticking to we're sticking to Zoom and uh Sundar Pachai respond says hey we'll follow up offline as we have an experience as read notes below it works pretty well in my experience we we will debug to understand the root cause and fix thanks for flagging thank you would love to switch if this is fixed uh and Nathan a buddy of mine says I have the inverse experience zoom is well rubbish in it and he's British or French maybe I don't know he's over in Europe somewhere I the specifics of that rubbish.

Anyway, in it hilarious. Um anyway, uh Teddy Blank had a coinage once your VC has uh what was it? The actual coinage was something about once your once your uh company's LinkedIn profile picture is the founder holding a microphone at a conference.

You're cooked with one of the Yeah, with one of those, which I don't think is really true necessarily because a lot of the big CEOs, they wind up doing that anyway. Bezos, Steve Jobs. I'm sure all these guys have been pictured with lav mics, but uh still funny to see that. Yeah, if you grow up too much.

So, anyway, shout out Teddy. Uh, anything else you want to cover? Should we get out of here? It's 205. Thank you for watching. Any more plugs? Got aurora. com. Go to luc. com. Should always go to Should always go there. Uh, but but uh no, I'm excited for the show tomorrow.

We got Brian Johnson calling in as well as Matteo from Eight Sleep. And uh yeah, go and leave us a fivestar review on Apple Podcasts or Spotify. Uh it helps us uh I think it helps us. I don't know what it does, but if you do leave a review, uh we will uh talk about it on the show and put an ad in it.

Keep tracking the largest company at the end of May. This is the Super Bowl of big tech. Microsoft's at 60% right now, but they dropped just recently. Um, down from 80%. This chart is actually Nvidia is climbing fast. Apple's climbing as well. Uh, it's a knockout dragout fight for the largest company at the end of May.

Head over to check it out. Anyway, thank you for watching. Talk to you soon. See you tomorrow. Goodbye. [Applause]