Uncapped #8 | Josh Kopelman from First Round Capital

[00:00] It was universally acknowledged. We're in a bubble. Everybody knew it. Oh, like the Fed chair, irrational exuberance, pet stock, comp stock puppet, like total irrationality. And if you had said, oh, no, we're in a bubble. And you said, I want to sell and exit now. You would have given up 83% of your profit. You would have made 17% of the total returns you could have made. All right, Josh, thank you so much for being here. I'm really excited to do this with you today. I'm excited, too. I want to start with the state of venture. [00:30] 2004. So it's over 20 years now, which is awesome. And you've seen a bunch of cycles and venture has changed like a huge amount in that time. And the lay of the land today is different than it's ever been. It's different than when I was building Lattice even, where now we've got not just like one or two big firms, but you've got like six or eight or 10 venture firms that are billions and billions of dollars. And we're not that big of an overall ecosystem in venture. And then of course, [01:00] categorically different because now you're hearing about firms that are playing different games than we've ever played before. And so I kind of wanted to start by just hearing your reflections of where we are as an ecosystem of venture generally around this dynamic. [01:16] It's been fascinating to watch. So I think we should talk about it two ways. The first way we could talk about it is... [01:23] How is it playing... [01:25] at the GP side and how's it playing at the LP side? Because at the GP side, right, in 2004, you had fewer than 850 funds. If you looked at like active check writers, people that were writing more than one check a year, probably 1,000, 2,000 people. Today, there's over 10,000 funds. You probably have over 20,000 active check writers out there. That's a change. And I think everyone's commented on it. And look, does it make the industry harder for VCs? Sure. Is it probably

[01:55] ideas. I think what hasn't been talked about are these fund size changes and what that means for LPs. You know, I think when we started, David Swenson pretty much like created the institutional venture asset class. He put us in business at first round at Yale. And you had like university endowments and a very select customer that basically said, we'll take illiquidity in order to get outperformance. And they really like those two match, right? You needed to have 10 plus years [02:25] And that was the deal. And it happened. And it happened, right? Like by and large, you had real good exits and it really created the asset class. But like, I think there are a lot of smart investors out there and smart VCs. And they said, you know, there's a lot of capital out there. There's capital that hasn't been able to get into this asset class. A lot of capital with like bigger purses, sovereign wealth funds, etc. And, you know, they might be willing, they might have a different cost of capital. [02:55] Thank you. [02:55] 12% IRR, and they'll take the same illiquidity. And when you bring new investors with different capital returns expectations, it could be really transformational for the industry. So, like, the bull case is the Blackstone-ification of venture, right? You know, what Blackstone did is say it's not about alpha, it's about scale, right? Let's give an example. If you had a billion dollars, and it was a traditional venture fund, and it could do 30% IRR, that's awesome. That's, like,

[03:25] 300 million dollars. [03:27] And if you [03:28] Now, on the other hand, if you had a $100 billion fund and it could do 12% IRR, well, that's $12 billion. That's a lot more than the $300 million in the first. So in terms of a total cash return from an asset under management, total profit dollars generated, like the Blackstone model won. And Blackstone, by the way, created an epic business. I'm not using this in any condescending term. [03:58] try to generate consistency of those returns and expand the asset class. So the bull case is that like what Blackstone did to private equity and other alternative asset classes, this new model is going to do in venture. The bear case is, and the story is still unfolding, so we have no idea what it's going to be. But the bear case is you don't get. [04:22] 12 or 14 percent return. You get like three percent return. Or zero or negative, right? Like if you look at the average venture firm, it's negative. And like like venture math is so tricky. Like when you look at like both the duration that's increased, when you look at the total venture dollars, like it's hard. So like obviously you've thought about this a lot. What's your sort of bottoms up way you think about a firm and its venture model and how it's going to get there? So I have spent a lot of time on it because like we every three years we go out and we have [04:52] And so – [04:54] I've created something which I don't think I've shared publicly, but I've run in time for. Here we are breaking the news. Let's call it the venture arrogance score. All right. So you take a fund.

[05:04] So say that fund is a $7 billion fund. Then you look and say, so you need two numbers to understand any fund's business model. First is how large is the fund? $7 billion. The next is what percent of a company do you think the loan on exit? And so like, are they going to own 30% like they did 20 years ago? Or are they going to own 8% or 10%? And like today it's trending to 10%, like, you know, whiz, an amazing exit, right? Sequoia owned 10%. Index owned a little more. [05:34] Like when you look at prices and the competitive nature, 10% is like a safe assumption, but you could plug in, you know, you could do the math yourself. So if you have a $7 billion fund and you're going to own... [05:45] 10% of the companies that you're in on average, you just figure out, okay, for each turn of the fund, that's $70 billion, right? Like the founders need to create $70 billion worth of value in your basket for your 10% to be worth $7 billion. So if you want to, now, if you're still aspiring for a 4X gross 3X net, which is sort of what like the venture long-term aspirational goal was, [06:15] So call that $280 billion. Right. And here's where the arrogance scale comes in. Because say you raise that fund every three years. [06:23] You know, that's roughly $90 billion a year of exit value that you hope to extract out of the market. And how much is exiting total? Well, like the last decade was the best decade ever. Yeah. $1.9 trillion total of U.S. venture. And that includes pharma and everything, like semiconductors. So let's just include it all. So that's an average of $180 billion a year. It's a median average.

[06:47] of about 100. So if you sit down and say- But the outliers matter. So we'll take the average. So it's like you need to catch half. You need to catch half. By the way, to my knowledge, there hasn't been a venture fund that has ever repeatedly caught over 10%. Yeah. So you're saying that you and your fund in this hyper-competitive environment with 10,000 funds and 20,000 plus check writers, you are going to capture half of all venture value created every year for the three [07:17] that could change. Number one is you could say, well, you know, for a $7 billion fund, if you're playing the Blackstone matter game, it's really about total cash returns, not alpha. So you could like reduce the 4X gross to a 3X gross to a 2X gross or however you want to do it and figure out what that math is. Or you could say that exits are going to go up. [07:35] you know, like AI is going to unlock some big things and the total value, which is probably true. But like, even if you take during the last decade, when that $1.9 trillion came out, 2021 was the best year by far. You had over $700 billion created that year. Even if you say that's the best year, you're still saying you're going to capture north of 10% in that best year. And by [08:00] $60 billion. So you're saying you're going, you know, we invest in cycles. So I think that, like, for me, like, the venture arrogance is trying to figure out what percent of total value created by all founders anywhere in the United States you have to capture for your fund model to be successful. I mean, we kind of collectively all need the totals to go way up.

[08:23] or else the whole industry is not going to make any money at this point, right? [08:27] I don't think people invest in venture expecting the whole industry to make money. If you look at the median fund return, even even like. [08:33] Primitive times, like in the 90s, it was the median fund didn't return capital. So, like, this has always been a game of outliers. I think, though, the challenge, like the difference here is that the aggregate returns, though, right? Like if you invested in if you just bought the entire basket of venture, do you lose money? [08:54] You lose money if you buy the whole basket of venture? Yes. So it's like you're trying to bet on a good poker player, and we all know there is a rake. It's that kind of dynamic? Yeah, I... [09:02] Yeah, I don't know if there's a rake. I think that the challenge is that [09:05] like structurally, there has always been a power law. There's always been like a few funds. And now the question in today's world, does like, you know, does the benefits endure to the same funds as it used to do? That's an unknown question. When you look at returns, [09:20] I think we've differentiated between private equity and venture capital. Private equity is control, much lower go to zero risk. Venture capital is minority. We have labels for those type of investments. And even in venture, we have labels for pre-IPO, early stage, late stage. And all of those have different risk and return characteristics. What's interesting, though, is that there are funds that are pursuing the original bespoke venture model. And I'm not trying to pass judgment on either of these.

[09:50] like cash on cash game, not the IRR game, right? So scale, not alpha. We don't label them differently. And in fact, the funds that are out there raising these larger funds are almost raising on their track record of being one of the smaller funds. And so like the question of what percent and what? [10:10] And again, if maybe a 2x is fine, but instead of 4x, but like, I think there's some combination of expected lower return because the source of capital is cheaper and expected, like, let's all hold on and make the bet together that the next decade is going to have $8 trillion worth of venture created in the US rather than two. And maybe that's fine also, but I don't, I don't see LPs actually doing the math and [10:40] What percent of all exits am I comfortable with? Am I comfortable with 30 percent? We've never seen a fund do that over and over. Am I comfortable with 15 percent? Am I comfortable? And so in the interest of looking to sort of like resolve what sounds like a big problem, what one counter narrative or one sort of sort of a. [11:00] An argument to this could be there's a lot of private companies that should be public but are actually staying private, and they're going to be worth hundreds of billions. And so you've got a bunch of companies like OpenAI and SpaceX and Stripe and Databricks and Rippling and so on. You have all these huge companies that are going to be huge, and it's going to be longer. And so actually you can put $500, $750, $1 billion into these companies, and there is actually a way to 3x a $5 billion fund.

[11:30] That makes a ton of sense. I would also say, though, as a counter to that, duration really matters. And again, maybe it depends if you're playing the cash-on-cash game or the IRR game. But let me give two funds. Okay, so the fund, 10-year life-size. First five years capital is called. The next five... [11:46] Like 1x gets done evenly over the second five. And then like there's three, 1x per year. So it's a 4x fund. 1x per year in years, 8, 9, and 10. So it's a 4x fund back-end loaded in distributions. 27.5% IRR. [11:59] Now let's take a same 4X fund, same 4X fund, same five-year upfront capital, same 1X that comes over the back end. But instead of 10 years, say it's 18, not 20, but 18. Years 1 through 8, no returns. 1X returned 9 through 18. And then 1X on years 16, 17, and 18. That's a 4X. So 4X funds back end loaded. That's an 11.5% IRA. And it's a 4X fund. [12:24] So now you sit down and say, okay, well, like we just said, maybe they'll accept lower than a 4X. Maybe they'll accept a 2X. Well, if a 4X fund over 18 years – [12:34] is like an 11.5% IRR. What is a 2X fund? What like, you know, I don't know my calculator, but I know it's less, it's not big. And like maybe T-bills are a better risk adjusted investment. [12:46] You know, [12:47] And so – [12:48] So I think like the argument that these companies are holding on for longer also means that you might have more duration risk. Right. And that also is an IRR killer. Yeah. If you had like a five billion dollar fund handed to you tomorrow and you had to do your best with it, what would you do? I don't know. Like, I don't know if I play the game because I didn't sign up to play an asset under management.

[13:18] stage when founders are just saying, like, imagine if we could do this. And I'm not looking to sort of play the access game, the poor lots of capital. Not saying there's anything wrong with it. Like you could, like founders need that product. Like LPs need that product. There's like, there's no judgment there. It's just not the game I want to play. It's a different activity. Yes. Do you think this, so this whole conversation we're having about return compression, professionalization, big funds, blah, blah, blah. It's very interesting to me as an investor. I think LPs should care a [13:48] Like, yeah, what if there are reasons, what are the reasons that a founder should care about this? Does it change the dynamics of working with those firms in any way? Is that does it matter at all? Or is it just like this is all good? There's more money. I don't know. I don't think founders have to worry about it, like to some degree. Like, did founders love it when there's more like when SoftBank came out with 100 billion dollar fund? That was a good thing for founders when it went away. OK, the capital got filled elsewhere. But like, I don't think it changes. And by the way, I don't think those VCs sit down and say, I want to fund mediocre founders with mediocre returns. [14:18] game, but they understand that if you're deploying that much capital, returns are probably not going to be the same. One of the things that has struck me is... [14:26] Imagine two funds. One is [14:29] a $500 million fund, and it does great. [14:33] and it hits like 15x. So it returns $7.5 billion. LPs are super happy, GPs are happy, everybody's happy. There's another fund that's a $5 billion fund. Yep. And it returns 1.5x. It also returns $7.5 billion. Obviously, the returns are different, people have a different amount of happiness, but maybe the GPs kind of make a similar amount of money. But um, GPs made more in fees? Yeah, the GPs made more in fees to me that kind of balances out. So I don't really know, maybe everybody's equal with it. But what strikes me is,

[15:01] The $5 billion fund... [15:03] probably has more relevancy. Like I think that firm, at least at a snapshot moment, probably is [15:11] choosing what areas get capitalized. They're out and about. You hear more about them. They have more partners. There's more people. They're more in the mix. They're around more deals. You see them in the news more. They're choosing what areas get invested in and they're deploying dollars. And so it seems like there's something twisted about that a little bit. [15:29] But you've seen this play out a lot over 20 years, and so I'm curious to hear, like, a more... [15:35] nuanced discussion about this. You're calling out... [15:39] a very real phenomenon. So look, in public markets, [15:43] If you want to invest in public markets, [15:45] Anyone could access any stock. [15:48] Right. So like if I want to buy IBM or NVIDIA, I could buy that. [15:51] There's no there's no credential that's required to gain access. But unlike public markets, private markets are very different. Access is highly competitive. And so. [16:03] founders are going to judge based on who is a really active investor, who's super connected, who has other founders in their portfolio that could be helpful, who has a lot of experience because they've deployed a lot of company adjacent like and so relevancy, as you define it, actually like. [16:19] It often creates access. And to some degree, like I've long said, in venture, activity begets activity. The more you write checks, the more relevant you are to other founders, the more founders refer you, the easier you have winning. There's the...

[16:33] an effect called the Matthew effect, which is based off of some proverb in the book of Matthew, where like, you know, to those who have that more will be given. And it talks about how like, compounding often happens based on like, it accelerates advantages. You know, in sports, people talk about the hot hand, right? Right. So like, oh, when Steph Curry is like on fire and sinking threes, there's the hot hand, it's actually called fallacy or phenomenon, because [17:03] is that like, oh, like because he sunk like he was three for three and three is the next one has much better odds of going in. Like there's proof either both ways. MIT just came out and said maybe there's a little proof. But in venture, it's 100 percent true. And the reason why is like ultimately the reason Steph Curry makes fifty five million dollars a year is because when he shoots, he hits a lot of them. Like if Steph missed all of his shots or 80 percent of his shots, he'd get paid less. [17:33] I'm stroking checks. I'm just hitting three, taking three after three. You get credit for attempting the shot. You don't get judged on whether that shot landed, right? So to some degree, while Steph's only going to get paid if his shots go in, some of these ventures get real compounding. And because of the venture, unlike private markets, there's the gossip mill, the speed of where a reputation for a firm or an individual can be created by activity,

[18:03] is super, super fast. There's also a dynamic of just like, you are part of the most important companies or you're not. And that doesn't include how many other investments did you make that did or didn't work out? What price did you pay, you know, to get into that investment? You're just... So I agree with you there. The asterisk I'd say is like, over what time period? Exactly. So like, there was a period of time [18:26] 2018 to 2021, where if I asked our founders who are series B and later, what funds you wanted the most in what I look at who they asked us to introduce them to the most Tiger and SoftBank. Kind of funny tidbit on that. There's I have some some friends of mine said something along the lines when like, you know, there were a bunch of firms leaking their returns and like or they got leaked, let's say. I don't know how they got out, but these returns got leaked. Some look really good. Some look whatever. [18:56] People are like, oh, man, wouldn't founders should just want the people who have the high returns. And I was like, you know, I'm still fresh enough off last. I'm like, why would I want why do I want a VC with killer returns? Who's going to give me a bad price and dilute me more? I want the one with the one X, one point five X who's happy enough to get by so that I can, you know. So but like so. Yeah, I agree. But like Tiger and SoftBank. [19:18] 2020 couldn't have been more relevant. And so I think that you have a two by two grid of like relevancy and returns. So you can sit down and say, like, if you have relevancy without returns, it's not enduring. Yeah. And by the way, there are also people with very different strategies who might have returns. But the hype to substance ratio is different. Right. Like if I look at like I'm not an investor in these funds, but like if I look at Founder Collective, like from what I know, they've got great epic return fund after fund. And it's so hard to do that. I wouldn't say that

[19:48] They played like the activity game. They're just good investors. IA Ventures, same thing. We invested with Altos and Roblox. Like under the radar, epic. And maybe like I would have put Green Oaks there, except now they've kind of become more relevant because they've gotten attention. But they've been pursuing that strategy. So I don't think there's any one way to play it. But I do think long term, long term, like to have an enduring franchise. You need good enough returns. It's about. [20:14] Like, [20:15] Checks. [20:16] deposited rather than like checks cashed. It's almost like I think what you're saying is they need to be sufficiently good to continue playing the game. It's not that they need to be so outlier great that that's what creates. I aspire to create something. And so I've put I we try to hopefully be relevant to founders, but we try to do it in a way that like aligns our incentives with our piece. Right. Like our partners make almost all their capital through carry rather [20:46] You know, small fund, but we have 50 employees because we want to invest our fee, not cash, not take it. But yes, I think there's like the model. There's so many different models and there's no one correct way. Right. Someone could look at like at our model and say we're going to make much less than a seven billion dollar fund. OK, so the dominant sort of venture theme right now, basically around these huge funds getting bigger and bigger.

[21:16] kind of keep scaling for those groups. And so that will be like the dominant thing. Most, you know, I saw some chart, you know, the top 10 venture firms are now raising like a very large percentage of overall dollars. So that's the main thing. There's this separate, you know, thing of, you know, there's a bunch of small firm, small, let's say, sub 500, sub 700, some number like that, that is like small enough where you'd say, you know, they can still, the venture arrogance score is not going to be crazy. And they can still drive like old school [21:46] So, [21:47] those bigger groups that have different incentives, can play the game differently, can therefore pay differently at a C or an A, like all these other things. What does that – where does that leave a firm – [22:00] like yours or mine or whatever, who is trying to basically exist in the context of that? What's our dominant strategy? [22:10] Well, I think, honestly, we're very aligned with our founders in that, like, [22:14] We only eat [22:17] if our founders create exceptional wealth. [22:19] Right. Like if their founders are exceptionally successful, whereas like a lot of these other funds, like they're making more in fees than, you know, than is a mad than was imaginable 10 years from now. So I think like from an alignment perspective, it works incredibly well with founders in that, like our whole focus is to like is to find ways to be the best potential partner to those founders to help them. [22:45] create something massive and not to settle for that 3x or that 4x return. You know, I think that

[22:52] I remember going back to Tiger, how Tiger, there was a year 2021. They almost did an investment a day, every day. They clearly did one every business day. I think it was 320 investments that year. That's a lot. What? That's a lot. It's a lot. And they had a whole series of we have all these consultancies and experts, et cetera. All that only scaled to the extent that they could raise their next fund. [23:22] Focus on what we could control. Could we be the best potential partner for the first two and a half years? Could we invest a meaningful amount of our fee stream into things that accrue value to our founders? Could we avoid the conflict that comes from sort of saying like, [23:40] from the founder thinking that we're going to want to pile tons of additional capital in, and therefore we're not truly aligned with them and trying to maximize the value for the next round, create an auction, maximize the long-term, you know, either short-term value for the next round or long-term value. Yeah. You know, but I'd say in general, this industry has gotten – [23:59] Far more competitive for all funds. Yours, mine, any size fund. [24:02] You've settled on doing something like 70 or 80 seed investments per fund cycle. Is that right? That's about right, yeah. [24:08] How did you get? Can you can you explain a little bit about like why you concluded that? Was that just a preference thing? Did it just match the model? Did you have some assumption of we're going to hit about this many? Like, how did you think about getting to that sort of? Yeah, it's a little bit about like we want to have make sure we have time diversification. So we aspire to invest over to at least two and a half, but ideally three years. We know that.

[24:30] We are ownership focused. Like we we we are we assume that we're going to get between 12 and a half and [redacted address] in. We typically take pro rata in the A. And so like our model, if you do our math, it's like we're trying to end up with, you know, seven or eight. I say eight, eight to nine percent ownership on exit. You know, do we always end up there? No. Have there been times where we had 15 of their times we've had six? Sure. But. [24:56] And so, you know, we look at our math and say that's one thing. And then we also just look at the mortality rate, the mortality rate of the industry, like the mortality rate from C to A, A to B, B to C. And we understand, like, we've been doing this so long that, like, [25:10] You know, it's like these startup founders are like running marathons. And there are so many that have great times at the third mile. There's so many that have great times at mile 10. And they're also like marathoners who sprain their knee at mile 21 and don't finish. Just like we've had plenty of companies that have gone on to be worth. I think we've had more than a half dozen companies that are worth over a billion dollars that went on to be worth zero. So when you sit down and look at the mortality curve. [25:40] to a billion and then a sub basket is going to make it all the way. That's right. Like you have to assume that there's going to be either founders that could have exited for 10 billion that choose to exit for one founders that you thought were going to exit, but they hit a curveball and like the market shifts or changes. And then it also matters, by the way, when you exit, like to some degree, when a company exits matters more.

[26:03] I don't think that people understand the... [26:07] the hyper concentration of [26:11] of [26:12] of returns in our industry. Well, they're very unintuitive because you always forget that you can add another zero and it's like very hard to believe it until, you know, it's like, I can't remember who I was talking about this with yesterday, but basically it's like, you know, an $8 billion outcome is like so outlier, but 80 is also possible. Yep. And like 800 is also possible. Yeah. And like the, the, every industry has a harvest cycle, but I think VC is, has a [26:42] globe. I use hype intentionally because it's like hype driven and hyper harvest. Some data from one of our LPs. [26:48] I went back to an LP who's been in the business for a while. [26:50] If you became a VC in March of 1980 and you had a 20-year career to March of [26:55] 2000, which was the dot-com crash. And I asked, like, what percent of your profits... [27:00] would have been generated in each year. [27:02] Almost all in 99. So 1% a year for the first 17 years, 83% in the last three. And why is that important? Because the last three, it was universally acknowledged. We're in a bubble. Everybody knew it. Oh, like the Fed chair, irrational exuberance, pet stock, comp stock puppet, like total irrationality. And if you had said, oh, no, we're in a bubble. And you said, I want to sell an exit now, you would have given up 83% of your

[27:32] the first round. We've been in business 20 years. We've generated over 90% of a return in a 36-month period of time during our 20 years. So we don't make our money in equilibrium. [27:43] Like you have the fear cycle, but you also like we don't even make our money in the green cycle. We make our money in the extreme fucking green cycle. We make our money when like Chamath is on CNBC every week pumping a different spec when there's like NFTs and crypto and corporate venture. Like for the last 40 years, all of those returns don't come from equilibrium. They come from like irrational disequilibrium. And the hardest thing that I've learned is like – [28:12] is having the discipline to hold on. Until then. Yeah, like we had a company that we partnered with the founder of Looker. They had a great exit in 2017, 2018. They sold to Google, I believe, for $2 billion. And it was like a good multiple. It was like 18 to 20x, like next 12 months ARR. Had that company... [28:32] Hold on. [28:33] for three years, same numbers, just different multiple, that company, look, or what are the same exact company, just a multiple expansion, that 2 billion would have been 8 to 10 billion. Just, just the difference between 2021 and 2018. And so like having the strength to hold on for a founder and a funder, like, you know, those movies, like where you see the, like the war movies with the people in the foxhole and like that with the bayonets and everything, like, and there's some like the commander saying, telling his troops, that's the enemy.

[29:03] The guys are so close. And you want to hold on until they get very close that you can hit as much as you can. Yeah. But you don't want to wait too long until you get overrun. Yeah. And like an adventure. It's crazy. The temptation to sort of exit early is like so value destroying that you'd almost rather the other sin, which is like hold on a little too long. Totally. And it's a really hard thing in this business. Now, it's also very tough because as the founder in that situation, you're like, wait. [29:33] Yeah, I don't have a portfolio. No, secondary. That's what I was about to say. Secondary changes that. Makes it a little easier. A funny thing you said earlier is I remember, you know, like you'll sometimes hear VCs complaining about founders taking secondary and they're like, this is misaligned. They're getting paid and we're not. [29:53] And what just occurred to me as you were talking earlier is if they've invested – [29:57] $150 million into the company, they actually are getting paid $30 million over 10 years just by their LPs simply for having written that check. And so, you know, it's all a little unclear sometimes when you really kind of pencil it all out. Yeah. And so, look, I think there's a difference between a founder taking some secondary to enable them to enable them to have a different risk profile. Like I think you want in the situations where they don't feel like they need to sell in order to lock in, you know, sort of securing a great life based on like, [30:27] A lot of years of hard work. Of course. Yeah, of course. I have no issue with it. I think that alignment makes sense. But I don't think that people understand the like the extreme concentration of exits. And so so put it another way, like you don't control when you exit. And you don't control when a founder exits and you don't control whether the multiple is 20 times next 12 months ARR or 80 times next 12 months ARR. But like,

[30:52] I think that there are signs of froth that you want to look for to at least get an understanding. Like, it's very hard in the moment to get like that map which says you are here to know where you are. It's funny because like usually when people talk about being, you know, a startup investor, you're talking about picking birds out of flocks and like it's individual companies. And I think that's most of it. But, you know, a lot said something really interesting, which I thought was really right, which is there's a lot of value to just picking the right theme. [31:22] at the right time or hard tech at the right time or robotics, hopefully at the right time or whatever. There's actually a lot of alpha just in getting that theme. And then if you focus on that at the right time, you're probably going to hit something. And... [31:33] You're saying another not bird in the flock point, not to take away from the bird in the flock point. Bird is very important. But like there's also a lot of value. Yeah, exactly. Of the when. And so if you think of these things of like what can you actually be good at, you can try to get better at picking birds out of flocks. But there's a lot of other value to these other dynamics, too. That's right. And I don't think a lot of VCs, so many of the funds are so new and so many partners are so new that I missed it.

[32:03] harvest... [32:04] like concentration and the like the the the fact that like we don't make our money in equilibrium. We make our money in disequilibrium. OK, so let's pretend that. [32:15] 18 months from now, it's hyper-harvest time. Yes. And you realize, because there's tons of IPOs, M&A's popping off, valuations have gotten stupid. You realize we're in that situation. SPAC 2.0, whatever's out there. CNBC's popping off. ICOs. All of it. There's like a new product. What do you do now? Knowing all these cycles, what is your behavior now, 18 months from now, when you're like, we are in a harvest moment? You don't want to be like, I think, to me- Like you're not calling founders saying sell your company. No, you're not. And you're not top-ticking the market. [32:45] There are times in many of these companies, they're so large that there's constant tender offers and secondaries. So I think as a fund manager, if there's opportunities, it's something to look at. And I don't think you're going to top tick, right? Like we did not top tick in some of our earlier exits, but we're able to take a 1x or 2x of the entire fund off and still be very long in that company. And so I think like that locks in a legacy that locks in a return. [33:15] Given what we just talked about, the time impact of IRR, it shortens the time to pay back if an IPO might be six years from now. But in general, it's also important just to show the founder the math. Sit down and see, how can I be aligned with the founder? Look, if there's no tender, we're not looking to sell. We're not looking to be competitive with the company. I think you're going to want to sit down and say, explain to the founder. Have the founder talk to other founders who sold before, maybe sold too soon, sold too late, IPO'd too late.

[33:45] My natural instinct I have to hold myself back from, which is, oh, we're in that. OK, this is the frothy part. Now is when we have to. And I think you oftentimes just need to hold. Totally. Just need to hold. Yep. Before we started this, we were just chatting about the Marc Andreessen's operating the world piece, which you reminded me was like written like around when I graduated from college. Yeah, like depending on when this comes out, it's probably about five thousand. Literally, I Googled it this morning, five thousand days ago. So you had just graduated Princeton. I love that. [34:15] And so where are we now? So talk to me about that. Did it play out? What do you see it as? Yeah, so what's interesting is I think that was one of the canonical pieces that changed almost the entire industry's framing. You could almost look at what was the venture industry before it. We funded software companies. And what's the venture industry after it? And so many people, like yourself included, anyone yourself or younger only knows the world in which software is eating it. [34:45] has eaten the world. [34:48] It's massively impactful. And he was right in so many dimensions. What's interesting is if you read that actual piece, [34:55] it mentions the word software 52 times. And like the basic gist of the piece was like, look, software ate advertising. Look at Google, look at Facebook, software ate this, and it has like 90 plus percent margins. So it got software like margins. But what's interesting is while the word software appears in the piece 50 times, the word margins is just assumed and appears there once. So it's like the assumption is that when software eats an industry, it has superior margins. And as a result, like the whole industry accepted that because it made sense. We

[35:25] Therefore, we expanded as an industry our aperture as to what's fundable. Like previously, a clinical care company, whether it's like smoking cessation, weight loss, like physical therapy, with human practitioners, never would have been a venture business. A bank wasn't venture fundable. An insurance, a health insurance company wasn't a sneaker company, a shoe company, a salad company. None of these companies were venture fundable before. Yeah. [35:51] But because the belief that software is going to eat the world, it expanded the definition. What's interesting is at least to date, there are clearly exceptions. There are clearly plenty of companies where software ate it. [36:02] And [36:03] They've generated meaningful margin superiority. But by and large, the margin test hasn't played out, which is why you saw a lot of this thing. Most industries have the same margin. They always did. Even with with with a higher R&D software expense. Right. So like you saw sneaker companies. [36:19] Building national brands. The founder did everything he expected. Like you had a pair of Allbirds. I had a pair of Allbirds. It was worth $4 billion because it was valued differently. But ultimately when you value it as a shoe company, [36:31] It's like [redacted address], I'm not throwing stones at anyone. Like we funded like tons of companies that have like in insurance in all of these areas where we believe that they would get meaningful margin superiority. Therefore, you get meaningful multiple superiority. And that's why we could justify investing in these at software prices. Yeah. To date. Yeah. [36:52] You haven't seen the margins that justify the superior economics. I think that's a host that like we're still working through that. When you look at the 2020, 2021 funding excess, you have a lot of companies that were funded at a margin expectation of margin superiority, which maybe now have like slight superiority or equivalence. But as a result, like the multiple is going to go back to the traditional industry that they're in. Like, is it are you an insurance company?

[37:20] Or are you a software company? And they're just, it's almost like a lost six to eight years to just catch up while the company continues to grow. If they can grow, to catch up. Now, there's plenty of footnotes and asterisks. There are companies where they have gotten massive margin superiority. There's the AI asterisk, which is like, now, finally, with all of the productivity gains of AI, you might massively see margin superiority come when software eats the world. [37:50] when software eats [37:52] Well, like when the world eats software, it hasn't. I think our assumption treated it as gospel. I know my firm did and almost every other firm that you would get margin superiority and multiple evaluation superiority, which hasn't translated. Was margin superiority the only thing like, you know, because as an example. [38:12] Eighth sleep. Yeah. You know, they're. Yeah. Yeah. [38:15] Imagining 8Sleep without software... [38:17] is a goofy experience. You could do it. Yeah, it'd be all right. Love my eight sleep. It's definitely better. And maybe these software is not helping their margin, but it's helping the product experience. Totally great. So we're getting more, we're getting more value. But go back to the examples even used in that piece, right? He, he says like electronic arts and Nintendo are stagnant and Zynga is the future. Yeah. Like Zynga had a very good exit. They raised $2 billion in private and public markets exit for 12. Yeah. But like those two stagnant and stale companies, Nintendo

[38:47] that amount, like $130 billion. I'm not saying that software is not creating transformational change. Of course, software is creating transformational change. It's creating opportunities for businesses. But the question is, if Eight Sleep ultimately is selling a mattress and doesn't have margin superiority against a mattress, how is it going to be valued? It's reminding me of a [39:10] point that I think, you know, like a Peter Thiel point around basically, you know, we see all the, you know, there's all this frenzy, but on the real metrics of like, you know, [39:20] like our [39:21] Are the homes high integrity and nice? How quickly do we travel? [39:27] What's the quality of life? How long do we live? All these things. [39:32] you know, what's really happened. You could paint a version of the world where we're kind of all like scurrying around building software, but like our food tastes the same. Our houses look the same. Our cars are maybe a little bit more like smart, but like they're basically the same. Yeah. Like they're better products. I'm not saying the products aren't better for consumers, right? Like, you know, an AI native bank is probably a much better experience than walking into a branch. An AI based insurance company, which could do prior off so much without the [40:02] than a 2002 Mercedes. That's exactly right. I'm not saying that the products are transformationally better. And like society in general is like massively benefited. I think Mark was right on most of the piece. The point I'd say, though, is like if you sell a car, that's a better car. And you have the same margin as like GM or Ford. Maybe you don't like. But like if you sell a mattress and you have the same mattress, the same margin structure, the same margin structure, the same structure, how are you going to be valued?

[40:29] Well, I guess the only way you'll get a better value is that you have higher growth as a result of a better product. That's right. Yeah. [40:35] And if that's how VCs underwrite companies, totally fine. But if VCs say, I'm going to underwrite this company by giving you a 20x multiple when the industry today has a 3x multiple, there's some real embedded assumptions there about profitability and future profits. What's the assumption that people are making with AI right now, do you think? [40:56] Like, what is the underlying, what is the implied premise of, [41:00] going into the way everybody's investing in AI right now that we'll just need to see if it's true. [41:05] I [41:05] Look, I've been through so many disruptive cycles. I mean, I was in college, you know, pre-web browser. When I was in college, I had to go ask for an email address. I got one of the first emails. Like, you've seen the mobile cycle, cloud cycle. Like, this cycle is probably amongst the most profound. So I'm like an AI bull. [41:25] I think that the key question is, [41:29] You know, I think if you're seeing anything like we're seeing, I believe that you're going to see massive scientific improvement in like health care, curing disease, energy, like, you know. [41:41] improving access to education, improving access to mental health, all types of health. I think AI is going to cause profound societal changes. But a large number of companies that we see every day are going to be, let's take this job. It's a line in the Bureau of Labor Statistics Employment, structural engineers. It is like medical billing. It's X, Y, and Z. And we could use software now.

[42:07] to [42:08] Um, [42:09] you know, to improve outcomes, improve productivity, and reduce the number of humans that are needed to do that. How that plays out societally is going to be really interesting. Does it change this, the categories of companies that you're [42:21] investing in right now as you're thinking about this? Like, are you are you to some extent trying to imagine what some of these impacts are going to be and then looking for a bunch of stuff in that area? Or are you still just going, I don't find the founder, find the bird? Yeah, we I don't think we're smart enough. We historically we haven't been smart enough to say like by the time something is such an obvious theme or obvious enough for us to figure it out, it's too late for seed stage investing. So so much of what we pick are people and problems. [42:51] We're trying to find like the right founder who has the right set of experiences, skills and characteristics to like pursue a really interesting and juicy problem. We don't we don't we don't really focus on their solution. [43:04] because at the time we see it, the solution is often wrong. So for us, it's more people and problem than solution. One of the things I've [43:12] curious about is you stayed like [43:15] extremely disciplined relative to your opportunity set. Meaning like most great seed firms, [43:22] evolve into multi-stages and growth firms and all the rest of it. And I know that, you know, you do it. You've done this because from the beginning, this is what you love. And like the early stages are what light you up. And my partners as well, because they they opted into this mission as well. First round is on one end of the spectrum of.

[43:41] Uh... [43:42] of sort of this focus. Another firm like First Round that I also respect deeply is like Founders Fund. And one of the things they've done incredibly well is just like real concentration. And you also, you know, in order to concentrate in big ways into your winners, first, you got to have big winners that can absorb that kind of capital. But you have had that. And you've also had the, you know, infinite LP demands and all the rest of it. Have you ever thought about [44:11] doing that and concentrating hard into your winners because it's right there. I'm just thinking on the back of this whole conversation, you've got all these ingredients. It's sitting right there for you. You let some growth firm come take this thing that you've worked on for, you know. Well, the founder worked on it, right? Yeah, but, you know, of course. So, yes. Have we thought about it every three years when we raise another fund? And have we increased our reserves for later stage? Sure. So, like, we... [44:34] You know, in the beginning, the majority of our fund was initial investments. Now the majority of the fund is some level of reserve for follow up. I don't know if we're good at it. [44:42] I don't like I think that I could say to a founder right now, I'm. [44:48] that I think there are a few firms as good as first round to be your partner for the first 24 to 36 months, the hunt for like massive product market fit, building culture, building team, figuring out pricing, positioning, all like all of that stuff. I feel like that's our power alley. I don't know if we would be the best partner for founders at the later stage. And maybe we're just like a dumb provider of capital. But for us, like I just feel that arm and I also feel alignment

[45:18] that? Which is that like you're never on the other side of a new deal. And the founder doesn't have to like feel like they're pitching. They have to get only give me good news and bad news because they want the big check. I don't have the big check. That is a big problem, actually. This is actually a big problem with the multistages in general is now that they're so big, like they never get to their target. There's no such thing as getting to your target ownership once your fund is big enough. You'd always rather have more. There's no such thing. So any great, large, [45:48] Why would I not want 40 if I think this is going to be huge? They always do want it. So I do think that is a tricky thing for founders to navigate. I agree. And maybe we're sub-optimizing. Like if I sit down and look at the decisions that we had to have created a lot of money, they're clearly the companies we missed on. Right? Like we missed on Airbnb. We missed on others. But there are also companies... [46:09] like right up there, which are like the series B or C round in an Uber, Roblox, Square and all these other companies that we were in. [46:18] I think there's something about the purity that speaks to our mission, that speaks to our founders, the alignment that comes from it. And like to some degree, like. [46:27] I didn't set out when we created first round, we didn't set out to say, how do we build [46:32] an institutional fiduciary investor, we said like the imagine if stage when a founder is just like looking at the world, seeing something different, saying, imagine if. Those are two powerful words. In fact, the most powerful words probably ever spoken, right? Not just in business, but like, [46:47] Imagine if no taxation without representation. Imagine if all children, like social movements, government, everything starts with a founder saying those two words. And so for me, what excites us,

[46:58] is like the stage where we get to like be partners in imagination. And, and, [47:04] To the degree that we are leaving money on the table by not like, I'm okay with it. You started two companies before First Round? [47:13] Is that right? Three. Three. So it was your fourth. [47:15] Kind of. Yes. Does it feel now that you've, you know, you've really been doing it and you've been through, I mean, hopefully it's got many more than 20 years to go in the future, but you've definitely really done it. And does it feel qualitatively similar or is it just have a different texture than building a company? [47:35] So there's a lot that's similar, right? Like I believe that we're in a very competitive industry. We have customers, our founders. We have investors, our LPs. We have a product that we need to put out to win. [47:48] I'm in sales, you know, like, so, and, and I also think like, [47:54] Like in startups, you're never done inventing. Like the best founders are both inventing and executing. And so I think first round today is very different than it was five years ago and 10 and 15 years ago. And I think first round five, 10, 15 years from now will be very different. So I like the canvas and the ability to sort of still feel like the hand on the paintbrush and create our own Imagine If. What's different, though, is the way that you create value is – [48:22] You create value in partnership with other people. You create value. The KPIs are really different. Like when you were an operator, you knew weekly, monthly numbers. You felt like you did something and you saw a result and you could look at cause and effect in very short term. I think in venture, like it's such a long game and there's so many like interim points along the way. That's what feels different. But the concept of like, I'm trying to build something.

[48:52] the culture I'm trying to build something differentiated uh like trying to find a hole in the market um uh [48:58] That I still enjoy, and I think that's a similar feeling. Can I ask you about Brett and his role a little bit? Sure. Okay, so one of my closest friends is Brett Burson, who does a role at first round, which is – [49:10] pretty unique, I would say, which is that he's a full partner, not investing. And [49:16] And I think very few firms have had the courage and foresight to create that kind of role. Can you talk about... [49:24] why you have that and because to me it's one of the things that creates such a lasting durability but [49:31] Yeah, I think... [49:33] I think we stumbled into it. And it was it's been one of the most impactful things we could have. So Brett started as an intern. Yeah. And also, I want you to describe what the role is in your work, because I've actually never heard you describe it. Sure. So I think like, you know, when you look at like most venture firms just operate like investors. We're a group of investors that sit around a table, make investing decisions. And as a result, most venture funds are very poorly run. [49:58] Right. Like there is no strategic planning. There is no R&D. [50:02] But there is no, you know, like, yeah, like if one of your startups ran like the most venture firms, you'd be like, what are you doing? Like, yes, like, like, if you sit down and say, like, how do we create our value, we create our value, like, in many ways, like a large part of the value, even though we have we have an incredible team that is working hard every day to help our companies win. Like so much of the value creates gets created just by like the way we make decisions. Yet most venture funds like don't even think about decision making as a product.

[50:32] It would be malpractice. Their valuation would like drop in half. But like every venture firm each week gets together, has like a great IP, like their discussion, et cetera, and just walks away. And like it's not cataloged anywhere. It's not learned from anywhere. So I think like what we believe at the firm is that like we want to operate like a company. We have products. We have experiments. We have like sprints and cycles. We have engineers that are building things. And Brent runs business. [50:56] all of that and by the way he also sits in on our investment team because being around for i guess 18 plus years he has i mean you also probably have to to do the other stuff well there's probably no other way that's right so i think for us like the way we could operate as a company is to have like a ceo like um um and and brett basically fills that role it's someone like and there's a difference between a maker schedule and not maker like right like you know you and i founder there's a round [51:26] to experiment with people [51:29] products, whether it's first round review, whether it's our angel track, whether it's our product market fit method, whether it's sitting down and saying, how could we help founders like raise their next round or what product could we build to do that? And so thinking, doing customer discovery, thinking in terms of product. Bridgewater does this. There's like, you know, when you join Bridgewater, there's like, you know, there's the investment side, there's the management side. And it's like our our only product is the way we make decisions. And so we're going to observe each meeting. We're going to like give ourselves feedback on the quality of that. You know, [51:59] Because you're not making pieces off, you're not making physical products, so what else do you have? And I think that in hindsight, when I look back at decisions we made,

[52:06] X years ago, memory is such a bad artifact to learn. That is one of the things I wonder about is because you don't get the feedback for so long. And so if you go back, you know, like seven years ago in that meeting, we passed for this erroneous reason. [52:20] There's a lot of learning. [52:22] And like, so one of the things we do, right? Like we'll prepare, you know, the point partner repair right up in advance, share it with the other partners. The founder will come in and we'll talk about the opportunity in themselves. And then after they leave, we actually created a 36% [52:38] question rubric that every partner [52:40] Every investor first round answers on their laptop prior to conversation. So prior to getting any outside bias to understand what the senior partner says or the junior, and they answer all 36 questions. So now every partner has to do their job, which is like state their point of view. And then we have a facilitated conversation where you're actually going like having a like trying to find not the points of agreement. We all think the market's great. We don't need to talk about it. But like if two people, really smart people who I view like I chose as partners, one of [53:10] is great and want to think the market is awful. Like that is a really juicy topic. And the other thing is it's great for like you're doing a case study almost every time. Every partner now gets to see what every other partner thought in 36 attributes on the founder, on the problem, on the product, on the market dynamic, on the traction to date, all of those things. And it just creates a fabric for real robust conversation. And it also creates a game tape to be able to look back on

[53:40] What did I not see? Or what did someone see? [53:44] in the meeting, but they got outvoted, right? Have you ever experienced a downside of running the firm this analytically, or do you think it's purely a positive? It just takes a lot of work. I don't think we're not trying. I'm not trying to say we make decisions by algorithm. I'm just saying we capture the root of our decisions, right? Like, so does it take time? Sure. Maybe it, you know, maybe it slows the process down and that has some opportunity costs there. It might cost us some partners who are not good at verbalizing. Like if a founder, if someone says, [54:14] think this is an amazing founder they're spiky somebody who's high intuition but can't defend what they think like a black box ai which who says the answer is x but can't show their work would have a really hard time in our model yeah but instead like what this gives you is you get to unpack every other investor around the tables like thinking and model um each week and and when you bring in new investors they could go back and look at the game tapes for the last five [54:38] for one of the companies over the last decade. Why is it so rare to have the Brett role at firms? It's expensive. And most firms don't view themselves as companies. They don't sit down and say, I need to invent. I need to create. They just say, I need to invest. And by the way, there are plenty of firms that just invest and do very well. I'm talking an opinionated way about [54:59] the one thing I know, which is our model. But that doesn't mean I have a negative opinion of other models, but at least from our perspective, so much of what we do has been created. Like, so while I might be a co-founder of the firm technically, I view Brett as like a founder of the firm, 'cause so much of what's been created, all my partners are founders of the firm. So much of what's been created has been their ideas, and the willingness to invest

[55:28] for a really long term, right? Like, so the ability to say, we want to try this hypothesis out and we'll fund it [55:36] for years. So deferred gratification, I think, is a really good thing in founders and in funders, right? Most founders experience extreme deferred gratification when they're starting something. They can make a lot more money and have a much easier life taking a job at Facebook or OpenAI right now. But instead, they're going to defer gratification today for something long. I'm like, as a firm, we've done that. Like when we started out, almost every venture firm says, all right, what's my management fee? That's the scale of what I could spend. Yet no startup says, [56:06] that's the scale of what I could spend, they invest ahead. So when we started, [56:11] Like, I didn't want to limit the scale of the opportunity to the scale of our fees. Yeah. So we operated on a deficit for seven years, you know, and the GPs funded the management company like. [56:21] almost $8 million of our own capital in the beginning, just to get started. And like, so, so much of what we try to do is like that deferred gratification. It creates a real alignment with LPs. And at least for us, the way that we see our firm, which is we're a firm that has products, that has services, that's running experiments, that's iterating and learning. [56:42] You need someone like a Brett to really quarterback that. Yeah, I think it's great. It also feels like it's set up for the future. Maybe that's like a topic we can we can wrap on is when you think about. [56:56] What you aspire for first round? Are you at a place where you're now like, we found our zone and now we just want to be it's Geo Dreams of Sushi now and we just want to be perfect at this. And this 20 years from now, the success cases that first round looks a lot like it does today, but we've just had exceptional funds. Or is there like a is there like a forever game in a direction that you're not there yet on? Like what's?

[57:26] I've unlocked it. There's no Jiro? There's no Jiro. Well, the definition of what is good sushi will be very different and what the market wants and what the market needs five, 10 years from now. So first round 2025 is very different than first round 2015, then 2004. And it would be rude to say, we figured it out now. It'd be like wrong, hubris to say, we figured it out now. Like, and 10 years from now, it's going to look the same. Like AI has totally transformed the way we do our job internally, and it's going to transform it in the future. And so I think what we've tried to create [57:55] So [57:56] is an iterative company, [57:59] That [58:00] invents and creates and is like deferring gratification to think to look around corners and to say, what do we want to build in the future? So I hope that's the machine we built rather than a machine that could just crank out the great like the old, you see these like 80s bands that like, you know, they're just saying they came out with something great idea years ago and they keep singing eight, six, seven, five, three, oh, nine. I'd like touring the country. Like, I don't think we could be an 80s band. Like, we can't just keep cranking out like what [58:30] we've tried to create is like a process and a machine and a team and a culture and [58:37] that [58:39] will evolve and grow to to create the hits 10 years from now 20 years from now we don't even know what type of music that's going to be yeah that's amazing all right well josh this is phenomenal thank you for making the time for this no thanks so much this is a lot of fun