Thread by @gdibner

Wow. Hearing of case after case of "big boy" Series A+ VCs literally fighting to stick big checks into very early-stage companies I'm not comfortable putting small checks into. This market is . . . . . interesting.

Assuming both the Series A+ guys and I am acting rationally and with some skill - what is going on? What explains the inverted risk curve of the VC market? After all, as a small first-check firm, I'm supposed to be taking MORE risk than they are.....

I think what has happened is that we have moved wholesale into a momentum market. What's a momentum market? The more money you raise, the more money you will raise. Because there is so much money looking for a home.

These numbers are off, but they illustrate the point: it used to be that VCs saw about a 50% drop off rate for each round of investment. Roughly half the pre-seeds converted to seed, half the seeds to A, half the A to B, etc.

In today's environment, this curve has shifted. There is so much money seeking exposure to private companies that the drop off rate appears to diminish. If 50% of pre-seeds convert to seed, 60% of seeds convert to A, 70% of the A convert to B, 80% of the B convert to C, etc.

As a first check VC investing in deeply contrarian (cliche, but true and I can prove it!) companies, I still see roughly the same risk (of company death) as I saw in 2010 and roughly the same valuations.

(Historically we've seen a very low write-off rate and a very high follow-on rate. And they haven't changed much.)

But the investors after us are living in (what appears to me, at least, to be) a vastly different world. There are so many new Series A, B, and late-stage players that the odds of a follow-on round are just MUCH higher than ever before. Valuations at these stages reflect this.

So we at first check are seeing roughly the same valuations and risk profile that we saw before, but with (1) vastly bigger outcomes for winners (Synk! Aquant! Firebolt! Dust!) and (2) much higher follow-on valuations that come faster than ever.

The funds after us (late seed, Series A) are seeing MUCH higher valuations, lower risk of failure, and self-fulfilling prophecies. The round they do seems to trigger the next one almost automatically.

As long as public market multiples hold up and exit values stay high - it's all good. All VCs stand to benefit. At some point, however, returns may diverge. Selective specialist first-check firms should outperform later-stage momentum indexers.

If you raise your entry prices by 5-10x, you better see 5-10x better exit valuations on average (doubtful) or have gotten 5-10x smarter just to keep performance constant. For us, however, 2x higher exit prices have huge positive impact even if we're no smarter than before.

But I think this explains the phenomenon I've witnessing of an inversion of the implied risk tolerance curve: with paradoxically more risky-looking behavior as you move downstream.

Another thing that has been pointed out in the responses to the thread and is worthy of emphasis is that a $2M check from a fund like Angular is 5% of fund. $10M from a $2B AUM firm is 0.5%. VCs funds are oversized to the point where they don't feel risk on a specific exposure.

It's critical to point out that all of this is divorced from fundamentals. I'd argue that because the first check VCs see more real and perceived risk, we tend too be more fundamental-driven. We have no choice. That's the job.

Interestingly, later stage VC which USED TO BE all about fundamentals and analytics, has morphed into being largely about momentum (will the next round happen? Yes!) and about indexing (given that the next round always happens, let's do everything!)

This makes the risk to late-stage VC much more systemic (beta!) and the risk to early stage VC much more idiosyncratic (alpha!). Over the long run, we're in the alpha business. ;)

Read/share this as a blog post: Alpha, beta, and an inverted venture risk curve. link.medium.com/JuoiFqc2hkb