Oct 14, 2024, 9:59 AM ETInterview, Fireside Chat

David Frankel, MP @Founder Collective: Investing Lessons from Seeding Coupang, Pillpack & Suno|E1214

Reserve Challenges: Managing fund reserves is identified as one of the most difficult aspects of venture capital, often plagued by the "negative correlation bias" where funds struggle to deploy capital into companies that need it most as market conditions shift.
DPI Uncertainty: David Friedberg suggests that Deep Performance Indication (DPI) could be "dead" for 2018+ vintages, with LPs questioning where the returns are in the current asset class.
Seed Round Inflation: Traditional seed funds ($50M–$100M) face challenges competing in a market with massive seed rounds ($6M–$10M) and inflated valuations, particularly in AI where deals can jump to $5B pre-money instantly.
Market Clearing Prices: While investors must pay market-clearing prices to avoid anachronistic deals, Friedberg notes that "AI prices" are distinct and that some deals require bowing out entirely unless personal conviction overrides all rules.
Fund Size vs. Return Math: Friedberg argues that the era of "fund-returning" giants is dangerous; a $10M check from a $10B fund dilutes less impact than a smaller fund where that same check represents a significant portion of the vehicle's potential.

Non-Consensus Investing: The strategy for success involves backing "non-consensus" founders (e.g., those with failures, non-traditional backgrounds, or in "orphaned" situations) and non-consensus markets (e.g., "cat food" or restaurant tech when the herd is chasing AI or DTC).
Team vs. Theme: Founder Collective prioritizes "teams over themes," believing that exceptional founders can find markets regardless of initial TAM (Total Addressable Market) estimates, and that 10x returns are achievable without needing "unicorn" valuations immediately.
The "10x" Rule: The fund adheres to a strict rule: if an investment cannot be 10x'd with high conviction, it is not pursued, ensuring alignment with the economic reality of a small fund.
Long-Term Horizon: Friedberg advocates for extreme patience, noting that consumer businesses offer fast feedback while enterprise SaaS requires "patience beyond anything else" and high pain tolerance.
Reserves Strategy Evolution:
- Fund 1: Operated with zero reserves, leading to a need to break rules for companies like Trade Desk.
- Fund 2: Implemented a reserve strategy to address the "negative correlation bias," though market shifts often render these rules obsolete.
- Current Approach: Maintains a "one-to-one" reserve policy but struggles because good companies often require capital before the market cycle dictates it.

The "Leech" Framework: Friedberg defines "LEECH" (Lethargic Economic Extractor Causing Harm) to describe legacy monopolies (e.g., Ticketmaster, PBM industry, live music incumbents) that use lobbying, legal threats, and capital to stifle competition.
AI Disruption: AI presents a new capital profile where incumbents (like record labels or PBMs) are being challenged by startups (e.g., Suno, SeatGeek), requiring VCs to act as "matchmakers" for legal and PR defense.
Board Alignment: Friedberg argues that economic alignment is critical; board seats should not be taken if the fund's ownership percentage is too small (e.g., <15%) to justify the time commitment against the potential outcome.
Founder Psychology: Founders with past failures often return "hungrier" and make better targets than those with past successes who may suffer from hubris; Friedberg emphasizes backing the "chip on the shoulder" entrepreneur.
Burn Rate Discipline: Friedberg stresses that entrepreneurs "own their own destiny" by managing monthly burn, noting that 90% of startups fail to secure follow-on funding, leaving many "orphaned" even after backing from major names.

Secondary Transactions: Friedberg advises founders to take 10% or less off the table in "hot" rounds to alleviate personal financial pressure (e.g., mortgages) without signaling desperation or angering investors.
Regretful Sales: He admits to regretting secondary sales in major wins like Trade Desk and Uber, noting that "never sell a single thing" is the ideal mindset for companies with true moats.
LP Distribution Strategy: Decisions on distributing IPO shares (cash vs. stock) depend on the size of the position relative to the fund; large positions are often distributed as shares to LPs, while smaller positions are sold and cash distributed.
PE as Liquidity Provider: Friedberg has shifted his view on Private Equity, now seeing them as valuable partners who provide financial rigor and potential acquisition exits for vertical SaaS companies, rather than enemies.

Capital Efficiency in AI: While AI requires significant capital for scaling (hyperscalers, TLMs), Seed funds should remain disciplined; investing at $25B pre-money is outside the "hitting range" for seed economics unless the team is unique.
Market Consolidation: Friedberg disputes the idea that AI will kill vertical SaaS, arguing that most companies lack the sophistication to build their own AI solutions and will continue to rely on data-enriched vertical players.
IPO Market Recovery: The reopening of the IPO market is expected to depend on "one or two great IPOs" (e.g., Stripe, SpaceX level) rather than smaller listings, which may not shift the broader sentiment.
Short-Term AI Disappointment: There is a consensus that short-term AI earnings will disappoint given the massive CapEx spend, but the long-term impact over the next decade is expected to be profound and transformative.

Running Tide: Friedberg recounts a total loss in a carbon sequestration startup, attributing the failure to an inability to translate a product vision into a commercial reality despite a talented founder.
Pinterest: Cited as a missed opportunity due to a conflict of interest with a portfolio company (Supply), illustrating the pain of adhering to strict financial rules over potential returns.
Olo: A restaurant tech portfolio company where Friedberg initially believed the business was lost due to a long sales cycle, only to have the founder ("pull the rabbit out of the hat") repeatedly prove the timeline wrong.
Suno: An AI music company currently facing legal challenges from the recording industry, which Friedberg views as a classic "leech" scenario requiring a multifaceted defense involving lawyers, lobbyists, and PR.

Book Recommendation: Friedberg is reading The Path Between the Seas by David McCullough, using the Panama Canal's construction (political lobbying, massive capital, high mortality) as a metaphor for the challenges of funding "moonshots."
Biggest Sin of the Era: The "Zerpa era" (post-pandemic) is defined by the sin of "too much money" shovelled down entrepreneurs' throats, leading to unproven expansion (e.g., Otter.ai in the US before proving the model in the UK).
Unmade Decisions: Friedberg identifies "unmade decisions" as the heaviest burden, noting that many of his biggest investments were not binary choices but 51% decisions driven by emotion and conviction.
Matchmaking: Small seed funds like his operate as "glorified matchmakers," spending significant resources connecting portfolio companies to the right partners at larger firms, a service larger multi-stage funds lack the incentive to provide.