Mark Suster: Why Private Equity Will Replace IPOs and M&A as the Exit Path | E1147

Market Valuations and Corrections

• The current market correction is described as taking another five years to complete, following two years of decline.
• Valuations in 1998, 1999, and 2000 are considered negligible compared to the overvaluations seen in 2021.
• Of the 1,221 companies achieving billion-dollar valuations between 2021 and 2022, approximately 1,000 are projected never to achieve an exit value of $1 billion.
• 60% of the 1,200+ billion-dollar valuations in 2021 were driven by only four firms: SoftBank, Tiger, Coatue, and Insight.
• SoftBank's typical deal structure involved writing $300 million checks at $4 billion valuations for companies that would not reach that value, leading to "zombie" companies where founders exited with cash and teams departed.
• The interviewee sold $1.2 billion worth of positions between 2018 and 2021, including $600 million specifically in 2021.
• Public market software valuations in November 2021 reached 24.6x next-12-month revenue, compared to a 10-year average of 9.6x and a 20-year average of 6.2x.
• Private market valuations in 2021 ranged from 50x to 100x next-12-month revenue.
• The interviewee purchased $50 million in secondaries in 2023 at deep discounts during a market downturn when other investors were fearful.
• Median entry valuations for the interviewee's portfolio in 2021 were $11–$12 million, contrasting with the $60–$80 million valuations paid by others for pre-revenue companies.

Venture Capital Dynamics and Fundraising

• "Lemons are ripe and early" describes a fundraising dynamic where "no" responses are delivered quickly, while "yes" responses take months.
• LPs often avoid giving direct rejections, instead offering vague feedback like "we need more traction," which translates to a decision not to invest.
• Some institutional LPs are currently "full stabled," requiring a "one in, one out" approach, effectively blocking new commitments.
• The "lines, not dots" investment philosophy posits that LPs commit to managers based on a pattern of behavior and resilience over time rather than isolated performance dots.
• The interviewee successfully secured a $22.5 million commitment from Morgan Stanley after six previous rejections, which subsequently catalyzed the rest of the fund's closure.
• The fund raised its 2012 fund in five months, a speed attributed to the credibility of the 2012 fund's success, whereas the prior fund took 13 months.
• The 2012 fund is projected to return north of 5x capital (cash on cash), with LPs receiving returns as the interviewee's strategy aligns with long-term holding rather than premature selling.
• The interviewee advises founders to close the minimum amount necessary to commence operations rather than aiming for a "one and done" full close, provided they have a narrative to explain the partial close.
• Institutional investors are preferred over friends and family for fund raises because institutional capital is more likely to participate in subsequent funds (Fund 2, 3, 4).
• Investors, including LPs, are described as "sheep" who invest heavily when markets peak and sell during downturns due to psychological stress rather than logic.

Investment Strategy and Sectors

• The firm employs a "multi-thematic" strategy with five or six distinct themes rather than a single concentrated thesis, utilizing specialist partners for each area.
• Specific focus areas include space (driven by SpaceX spinouts), national defense, healthcare, and clean tech.
• The cost of launching a startup dropped from $5 million in 2005 to $500,000 in 2009 due to AWS, fueling a Cambrian explosion of software startups.
• A similar cost reduction has occurred in space launches, with Falcon 9 reducing the cost per kilogram to launch by over 90%.
• More than 100 spinouts from SpaceX have raised over $10 billion, with the majority based in Los Angeles.
• The interviewee invests 42% of the fund in the first check and reserves 58% for follow-on rounds, categorized into three buckets: non-viable companies, clear winners, and the "messy middle" requiring capital to cross a hurdle.
• Some portfolio companies have taken an average of six years to raise growth rounds, allowing them to become more capital efficient than those that raised too quickly.
• The interviewee cites Ring (seed investor) and Nanit (baby hardware) as examples of successful hardware/software investments despite skepticism from the broader VC community.
• Generative AI seed deals in 2023–2024 are priced at a 44% premium over standard seed deals, while B-rounds command a 200% premium over enterprise software, indicating a lack of arbitrage opportunities.
• The interviewee warns that betting on generative AI in 2023–2025 carries high risk because the market has already priced in the "trend of the day," and returns will be difficult to achieve at these entry prices.

Operational Challenges and Mistakes

• The industry currently faces a "liquidity crisis" with IPO markets shut down and M&A activity suppressed by regulatory bodies like the CMA (blocking Figma).
• Private equity firms are expected to become the primary buyers of venture assets, but they will purchase at rational prices, exposing the error of irrational entry valuations.
• The interviewee identifies ego as the driver of a major past mistake where a rapidly growing company was funded to the point of dilution, resulting in a $350 million offer being rejected and a eventual zero exit.
• Fraud and founder misconduct are rising, with specific instances of founders embezzling millions and settling with VCs for stock returns while keeping the cash.
• The interviewee advocates for a 70% focus on founder selection, believing that great founders can pivot markets if the initial opportunity is misidentified.
• Short-termism in founders, seeking quick exits for modest gains rather than 12–15 year horizons, is identified as a critical failure mode for venture returns.
• Reserves are not sustainable for "rocket ships" (companies with massive traction) if the valuation does not support future growth; the interviewee refused to invest in a company that reached $500 million valuation without the traction to support it.
• The interviewee notes that while writing checks is easy, driving returns requires seeing hundreds of deals to identify the few viable opportunities.

Personal and Political Commentary

• The interviewee acknowledges Passover as a time of returning to an ancestral homeland, noting the ongoing hostage situation in Gaza with 130 people held, estimating 20–40 may already be deceased.
• There is a stated concern regarding the rise of anti-Semitism, particularly among the "extreme left" and on university campuses like Columbia, where Jewish students are described as targeted.
• The interviewee expresses skepticism about the current US political landscape, preferring a third option to both Trump and Biden, citing concerns about democracy and the radicalization of both the far-right and far-left.
• Historical context is provided on anti-Semitism, noting it as a millennia-old phenomenon that resurfaces during political shifts, such as the Bolshevik revolution in Russia which initially promised equality before targeting Jews.
• The interviewee emphasizes that the land of Israel was acquired primarily through purchase in the late 1800s through 1947 prior to the state's founding.