Aug 23, 2023, 2:56 PM ETFireside Chat, Roundtable, Interview

Jason Lemkin & Rick Zullo: How "Mark to Market" Corrupted Venture Capital | E1052

Shift from Hands-on to Asset Management: The industry is pivoting from a founder-centric, high-touch model to an asset management model focused on scaling capital and fees rather than investor-founder relationships.
Fund Size Inflation: Larger funds (>$2B) require $100 billion+ outcomes per fund to generate returns, making the $10 billion "unicorn" the new standard, which forces early-stage investors into highly competitive and difficult positioning.
Mega Fund Resurgence: Despite current LP tightening, speakers predict a resurgence of mega-fund fundraising in late 2024 and 2025, driven by the eventual return of liquidity and historical cycles.
Strategic Splintering: Major firms (e.g., a16z, Sequoia) are likely to splinter into dedicated sub-strategies (e.g., growth, seed, buyouts) to apply rational math to specific fund sizes rather than forcing a single strategy across a massive capital base.
Decline of the "Factory Model": There is a consensus that the current "factory model" of scaling venture deals has disconnected VCs from founders, leading to unhealthy behaviors where capital is deployed without sufficient operational alignment.
Investor Incentive Misalignment: Seed funds are increasingly pressured to provide large checks ($2M–$5M+) that create "hostage" situations, leaving founders unable to raise subsequent rounds if they fail to meet inflated valuation expectations.

Capital Abundance Fallacy: Founders are criticized for treating increased capital ($8M vs. $2M) as a mandate to overspend rather than extending runway; the primary job of a founder is defined as "not running out of money."
Efficiency vs. Growth: Public market pressure has forced B2B SaaS companies to pivot from growth-at-all-costs to profitability, with some companies (e.g., Monday.com, Toast, MongoDB) moving from negative to 20%+ operating margins within a single year.
RIFs (Layoffs) as Strategic Necessity: While ideal companies should avoid layoffs, investors acknowledge that right-sizing via RIFs has become a common "data point" for portfolio companies, though founders often lack the perspective to implement them timely.
The "Pass" is Over: The market tolerance for low growth and high burn has ended; founders must either return to triple-digit growth or pivot to capital efficiency, or risk failure in the current valuation environment.
Stair-Stepping Strategy: Successful fundraising now requires a "stair-stepping" approach where founders and investors are confident in a 3x valuation increase for the next round, rather than attempting to force a "flip the card" decacorn outcome immediately.

Valuation Corrections: Speakers suggest valuations over 15x ARR are currently suspect; some advise marking down portfolio companies with 50-60M revenue and $1.5-2B valuations by 50% to reflect reality.
Mark-to-Market Corruption: The practice of paper markups during bull markets has corrupted the industry, inflating IRRs artificially (e.g., 140% in Year 1) and creating misaligned incentives for both GPs and LPs who were compensated on paper gains.
Trust Deficit: LPs are experiencing a significant trust deficit due to inconsistent book values across managers; the prevailing strategy to restore trust is under-promising and over-delivering rather than aggressive fundraising.
Secondary Market Discounts: Severe discounts (e.g., 1x to 7x fund returns) are being observed in secondary markets for funds holding highly priced, non-liquid assets, particularly where SPVs failed to deliver liquidity.
Bridge Rounds vs. Down Rounds: A "messy middle" of companies is expected to slip through the cracks, leading to "bus" (business failures) and bridge rounds rather than a wave of traditional down rounds, as salvage value management becomes a priority for boards.

Salesmanship vs. Substance: There is criticism that the ecosystem is overly focused on "salesmanship" and pitching (both by founders to VCs and GPs to LPs) rather than substantive business analysis and financial acumen.
High Bar for Deal Flow: Top investors (e.g., Harry Stebbings) limit new founder meetings to roughly 3 per week to maintain deep research and conviction, rejecting the "spray and pray" volume strategy.
Competitive Landscape: The collaborative phase of early-stage investing has ended; top-tier firms are now viewed as purely competitive, with referral networks becoming transactional rather than cooperative.
Thesis Rigidity vs. Opportunity: Rigid thesis-driven investing has led to missed opportunities (e.g., Archer Aviation), prompting a mindset shift toward evaluating founders based on their potential to "change lives" rather than just fitting a specific sector thesis.
AI Investment Surge: Venture capital spending on AI is predicted to double in 2024 compared to 2023, driven by the inability of massive capital to deploy in traditional SaaS at current valuations and the concentration of funds into major AI players.

2024 AI Spending: Consensus bet that AI VC spending will increase 2x in 2024, with capital consolidating around a few large platform companies (e.g., OpenAI, Anthropic) rather than spreading across many startups.
Fund Longevity: A significant risk is the survival of multi-stage "zombie" funds; many current Series A/B/C investors may not remain active in the market 3–5 years from now.
Scaling Barriers: The most common reason companies fail to scale from Seed to Series A is "good but not great" growth (e.g., 80-100% growth) rather than the failure to achieve the 100%+ required to sustain venture-scale economics.
Board Dynamics: Founders generally fail to understand that board control correlates with cap table ownership; boards currently exert less influence than 5–7 years ago, but this will likely shift as companies require bridge funding.