Interview, Fireside Chat
Jason Lemkin: Why Pricing is Worse Than Ever and There is More Funding Than Ever | E1157
- The current seed investing environment is described as "systemically broken" due to capital chasing fewer companies capable of triple-digit growth, resulting in insiders flooding quick-growing firms and creating overfunded entities at inflated valuations.
- To successfully approach an IPO, companies must achieve 10% market share in their core ICP, reach $10 million in revenue within five quarters or less, and demonstrate triple-digit growth rates such as tripling or doubling revenue repeatedly.
- Financial health thresholds include a monthly churn rate of 3% or less for software models, with rates exceeding 3% or 4% indicating a shift toward consumer product dynamics; additionally, enterprise companies at $1 million revenue require Net Revenue Retention (NRR) above 110%.
- Gary Tan anticipates that investments with high Net Asset Value on paper will flip to become the most profitable by cash return in three to four years, while 10x features may mask poor software quality up to $1–2 million in revenue before competition overwhelms the firm in that same timeframe.
- A 50% dilution during the journey to IPO renders traditional seed funds insufficient, as a 6% ownership stake in a billion-dollar exit yields only $60 million; achieving $100 million+ returns will likely require two $3 billion exits.
- Dilution risks are exacerbated by low seed ownership stakes (e.g., 10% or 12%), which can shrink to single-digit percentages that fail to return the fund, a structural issue Tan views as a "feature, not a bug" of the current market rather than an error by incubators like YC.
- Gary Tan plans to prioritize diligence by verifying a "great CTO" and "great CEO" immediately, skipping other management teams for companies under 10 employees, and will check bank accounts and financial accuracy (targeting 80–90% accuracy) at the start of the process to avoid shenanigans.
- Growth expectations include an "8% a month" baseline at $1 million revenue, though double-digit growth at single-digit millions remains a high bar; hyper-agile engineering can turn high competition into a net positive if the company pulls away within four years.
- Founders are expected to face a "second act" requirement upon hitting 10% market share to avoid growth stalling within 24 months, while founder-led expansion into new categories carries risks of rigidity contradicting market logic.
- Exit strategies involve liquidating positions immediately upon founder departure due to lost competitive agility, and Tan expects to agree with sell decisions rather than playing devil's advocate.
- Public market conditions predict that low-growth companies with single-digit market caps will become PE targets for financial engineering, while zombie public companies with 40% operating margins may run as cash engines before reigniting growth; a multiple expansion from 6x to 8x could revitalize deals made in the current downturn.
- High burn rates, such as $50 million, are viewed as "crazy bets" without a clear path to profitability, whereas SMB companies tolerate 3–4% monthly churn but exceed the SaaS model if rates rise further.
- LPs are expected to grant "mulligans" for 2021 deals, potentially accepting 1x returns on bubble deals without criticism, but holding 2021 deals to 2024 AI deal standards would be "brutal."
- Investors may miss "Datadog"-scale outliers by avoiding competitive spaces, as the best opportunities often appear when others are passing, though funds may cease operations if they cannot replicate $300 million returns from single exits like Datadog.
- Long-term growth in the teens (e.g., 15%) over a decade can still satisfy the "Rule of 40" and maintain enterprise value, suggesting a potential decade of runway, but high entry prices like Calendly at $3 billion offer significantly lower return potential than historical low-entry investments.
- Challenges in the current market include catching "cynics" and "bullshit artists" due to reduced founder meeting time, and Tan warns that smart founders often remain too stubborn with bad executives for too long, leading to poor outcomes.