Jason Lemkin: Why Pricing is Worse Than Ever and There is More Funding Than Ever | E1157

Market Conditions & Investment Philosophy

• Seed investing is currently "systemically broken" due to a scarcity of capital-efficient growth targets.
  • There is "just as much capital" chasing "fewer and fewer folks" capable of growing at triple-digit rates.
  • Most startups can only secure IPOs if they triple, double, and triple again in revenue trajectory.
• The ideal investment profile has shifted to companies that grow from $1M to $10M ARR in five quarters or less.
  • Founders must be ready to expand beyond their core Ideal Customer Profile (ICP) upon reaching 10% market share.
  • Churn rates exceeding 3–4% monthly render the business model invalid for software, effectively making it consumer-like rather than recurring.

Best Cash Returns: Salesloft, Pipedrive, and Logical

• Salesloft: The top cash return for Jason, selling for $2.5B in cash at ~$100M ARR in December 2021.
  • Jason co-led the seed but assembled an almost entire cap table with Immersion and Insight.
  • The investment survived an 80% revenue drop (from $8M to near zero) as the founder pivoted the product; Jason learned that "ultra-insane commitment" and a "binary pair" of founders (CEO + CTO) are non-negotiable.
  • Lesson: Founders who are "kind" (like Kyle) can still push for the right exit; investors should trust a founder's decision to sell even if it contradicts VC optimism for a higher valuation.
• Pipedrive: The second best cash return, selling for $1.5B to Vista at ~$100M ARR.
  • Investment made in 2013 at $1M ARR with 100%+ year-over-year growth.
  • Outcome hampered by having five co-founders, making decision-making difficult.
  • Lesson: When founders leave, investors should liquidate positions; HubSpot's founder-led expansion eventually cannibalized Pipedrive's market, demonstrating that founder-led agility often beats professional management in pivots.
• Logical (Smaller Harry): The third best cash return, sold for $300M.
  • Jason owned ~20% via multiple entities, generating a ~$60M return.
  • Demonstrated that owning a "tenth of a percent" in a fund is insufficient for material returns; dilution is a major headwind.

Investment Process & Due Diligence Evolution

• CTO-Centric Due Diligence: Jason now prioritizes the CTO interview immediately, often as the second call, rather than late in the process.
  • Great CTOs demonstrate "surprise and delight" and can build software faster than competitors; they are "hyper-transparent" about frustrations.
  • Mediocre CTOs hide behind pleasantries or "great" status reports; great CTOs reveal specific, technical grievances (e.g., API costs, workflow bottlenecks).
  • At $1M revenue, software must not be "slow" (e.g., dashboards resolving in <20 seconds); slow performance at this stage predicts failure at scale.
• Financial Diligence: Moved from end-of-process checks to immediate "bank account" verification to detect "bullshit" or fraud.
  • Jason requires 80–90% accurate financials; he refuses to invest in companies with manipulated metrics.
  • He avoids "follow-on check" syndrome, where investors double down without checking the fundamentals just because top-line growth looks good.
• Team Composition:
  • Investors should ignore the rest of the management team if the CEO and CTO are a "binary pair" of great commitment and talent, especially in early-stage companies with <10 employees.
  • The "10x feature" can mask poor software quality early on, but without a great CTO, the product fails to scale as competition emerges.

Metrics, Churn, and Growth

• Churn Thresholds:
  • Enterprise: Must achieve >110% Net Revenue Retention (NRR) at $1M ARR; anything less suggests a broken business.
  • SMB: Monthly churn must be ≤3–4%; >4% indicates the business is not true recurring SaaS.
  • Investors should reject companies with >5% monthly churn unless they have a clear, executable strategy to transition to mid-market or enterprise.
• Growth Expectations:
  • Companies must grow 8–10% month-over-month at $1M ARR to reach IPO viability.
  • Revenue projections must be ambitious; founders presenting modest targets should be challenged to self-correct.
• Burn & Capital Efficiency:
  • David Sacks' burn ratios (≤1x revenue) are only efficient with >120% NRR and high margins; SMBs with lower retention require much tighter burn control.
  • Investors warn against "zombie" public companies (e.g., Dropbox, Box) that are profitable but lack innovation; these are often targets for Private Equity to cut costs rather than reinvigorate growth.

Market Dynamics & AI Trends

• Competition:
  • Investors should not avoid competitive markets entirely; hyper-agile teams can use competitors to educate the market and grow total addressable market (TAM).
  • However, "hate investing in competitive markets" if the deal is marginal; if the founder/CTO pair is "binary," the competition is a net positive.
  • Vertical SaaS with "no competition" (e.g., against Excel) often hides mediocre engineering or lack of a CTO.
• AI & Valuations:
  • Early AI tools with explosive growth but massive burn rates (e.g., $50M burn for 1→$12M growth) are high-risk bets where the path to profitability is unclear.
  • "Low ownership stakes" in seed rounds (e.g., buying 1% at $25M pre-money) are structurally broken; founders do not realize VCs need larger stakes to return a fund after dilution.
  • Y Combinator's "feature, not a bug" approach of spreading small stakes to 150+ companies makes it impossible for traditional VC funds to maintain significant ownership.
• Insider Dilution:
  • Top decile companies are being "flooded with insider capital" by large funds ($10B+) refusing to share cap tables, inflating valuations and reducing the ROI for early investors.
  • "Structured rounds" and "flat rounds" are increasingly used to hide poor performance from the market.

Specific Lessons from Losses & Misses

• The $5M Loss (2021):
  • Resulted from writing a third check into a company after the CEO misrepresented financials (crossing the "bullshit line").
  • Lesson: Never write follow-on checks without rigorous diligence; "zero diligence" on follow-ons is a systemic error.
  • The founder's stubbornness in retaining a terrible CEO and hiring 25 low-performing sales reps created a "high burn pickle" that forced a suboptimal exit.
• The $3M "Win" that was a Loss:
  • Sold for $100M (5x return) during the 2020 lockdown, but should have been worth significantly more had it not been sold.
  • Founder sold too early due to panic; lesson is to trust founders' strategic decisions to sell only when they explicitly push for it as "the right thing to do" for the company's health.
• Recycling:
  • Jason regrets not recycling capital from early exits into new portfolio companies; he wishes he had retained millions to deploy in 2020–2021.
  • End-of-fund thinking (investing to recycle for "free carry") is dangerous; treat final checks with the same rigor as the first check.

LP Relationships & Fund Management

• LP Concentration: Jason recommends working with 4–5 LPs who truly believe in the investor (e.g., Horsley and Transpose affiliates) rather than managing transactional relationships with hundreds.
• Fund Longevity:
  • Many top firms are "quietly stepping back" or losing partners; the "sparkle" of making billions on one unicorn (e.g., Datadog) often leads to disengagement or retirement.
  • If a firm has one outlier exit but struggles to find new ones at similar valuations, it is rational for partners to exit the business.
• Individual Investing:
  • Jason advises individuals to invest in index funds (S&P 500) rather than venture funds; the illiquidity and low multiples for small checks ($50k–$100k) do not justify the effort or risk.

"Under the Radar" & Public Market Observations

• Underrated CEOs:
  • Anish Agarwal (ServiceTitan): Highly committed, solving hard problems in trades.
  • Andrew Bialecki (Klaviyo): "God level" founder dominating Shopify's ecosystem; Jason wonders why the market cap is only $6.5B despite near-universal product love.
• Public Market Valuation Dislocations:
  • Klaviyo (6x ARR) is significantly undervalued compared to Atlassian (12x ARR) despite similar growth and cash flow, suggesting broader SaaS is mispriced.
  • Companies like Anaplan and Marketo are "stuck" with legacy tech; their ability to grow in the teens depends on niche enterprise stickiness rather than innovation.
• Exit Strategy:
  • VCs should liquidate positions when founders leave the company to maintain competitive agility.
  • "Good deals" do not guarantee "great investments"; the focus must remain on founder commitment and product quality, not just valuation.