Thread by @tylertringas

What the heck is going on in VC/early stage right now? My theory:

Mega funds have found a new product for their LPs that allows them to invest in the same companies with an approach that is completely disrupting VC 🧵

The original "product" that VC funds were selling to their LPs (ie endowments, pension funds) was: relatively small funds shooting for huge outlier individual investments that translate into outlier fund returns. The "power law" you've heard so much about.

The features of the product were (1) long-term illiquid investments were uncorrelated with the market and (2) if the funds hits a 5-10x+ grand slam it will move the needle for their LPs' overall returns with a relatively small investment

But the market has changed radically—yields on safe assets are terrible, interest rates are zero, the market isn't pricing risk, capital is overflowing, everybody is YOLO'ing—which has *huge* pools of capital seeking desperately for any source of returns

Megafunds like Tiger, Coatue, a16z, and recently Sequoia have figured out they can sell their LPs a new product: okay-ish returns (nothing like traditional VC targets) but in a way that can soak up billions in capital and still get a decent return.

The primary motivation of these funds is to put 10s of millions into individual growth stage tech companies and get reasonable-ish returns, but in part because the people there are VCs, and in part because of formal/informal pro rata, they're doing early stage too

But when they invest early stage they have entirely different motivations than the traditional seed stage VC (or angels for that matter) who are trying to get a home run return. They mostly view the $1m in a seed round for the option value of putting $50m+ into the Series B-D

This means they can accept higher valuations and lower returns than investors who are actually trying to get their returns from the seed/Series A. Even if they aren't winning a deal, they're inflating valuations to a point that breaks the old VC model.

I've been asking this question for a while now and the generally accepted answer is that seed VCs and angel have their head in the sand just plowing ahead with a model that's been broken by market conditions

https://twitter.com/tylertringas/status/1302975678434942980?s=20

Nobody is even bothering to articulate how you can invest in seed rounds at $30m+ pre and still generate competitive returns. Either "picking winners" is just insanely easy now or the distribution of outcomes has structurally 10x'd in a few years.

Seed VCs will just say "shrug, $10B is the new $1B" without bothering to make the case that either change (in success % or total return) is actually true. It is *possible* but I don't see why we can just assume it is.

The only reason this isn't a crisis right now is that enough early stage deals are getting paper markups when Tiger et al comes in a later round, making paper fund performance look great.

But if tech companies don't start magically IPO'ing for 100x+ revenues, the actual cash distributions from these early stage investments are going to be terrible and many funds will evaporate (megafunds will still hit their much lower return targets).

Overall I think this is a good thing. I've been arguing that small funds focused on one stage have hampered innovation and incentivize a herd mentality.

https://twitter.com/tylertringas/status/1126834338979512320?s=20

And the two resolutions for these problems are (1) megafunds that can back companies from seed to IPO and (2) strategies that genuinely back different types of companies and aren't dependent on follow-on rounds

https://twitter.com/tylertringas/status/1126860572119769089?s=20

Our strategy at Calm Fund to adapt to this is to double down on funding companies outside the VC thesis, focused on niche markets, creating real revenue and value, that don't need to ever raise another round (and if they do it's on their terms).

FWIW I published all this several months ago in a note to our LPs calmfund.com/for-investors