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

1. 0:00 – 2:21

   Why VC Needs a "Jerry McGuire" Moment

   1. JLJason Lemkin0:00

      I don't mean to be patronizing but I mean to be a little bit patronizing. As a founder, your job is not to run out of money. If you got eight million instead of two million, it's not to spend it all. Why are they spending it all? The great founders are going big. Why can't they use a spreadsheet and do the math and say, "I got a gift from heaven, why can't the best founders take advantage of this?"

   2. HSHarry Stebbings0:17

      (instrumental music) I am so excited for this. This is gonna be such a fun discussions today. Now, we're gonna dive right in because I got teed up by a comment from Rick First who said that, uh, we need a Jerry Maguire moment in venture. I love Jerry Maguire but I was intrigued. What did you mean by this, Rick?

   3. RZRick Zullo0:37

      So, Jerry Maguire is one of my all-time favorite movies. Like, part of me really wishes I was a sport agent. Um, you know, and for those who don't know what this movie is about, Jerry is this kind of soulless sports agent working in this big agency that has come ... And he has kind of a come to Jesus moment and he realizes that they're working with too many clients, they're trying to scale too much, you know, that they've lost the kind of, like, hands-on connection with their clients and that they need to go, like, back to the core business, focus on the clients over making money. He writes this big ma- manifesto, Catch On The Rise style, uh, and then he ends up getting fired for it. But all ends well that ends well. You know, he ends up developing a close relationship, helps his client through a bunch of these struggles, and, you know, hilarity ensues a- all along the way. And, you know, in many ways, I think this is what venture used to look like. It was a really hands-on connection between a board member and a ma- and the founder. Uh, and then you guys talked a little bit on your last round table about this factory model, and I think that's really torn that a- all out of whack, where it's become about how much we can be an asset management business, how much we can scale the capital that we have, and that's really taking VCs away from the founders, um, and really focused on some things that I think are some really unhealthy behaviors. But make no mistake, the asset management business is a better business than the venture business. You know, fees are guaranteed, carry isn't. For me at least, early in my career, like, we had these... I had two big nine-figure exits that were founders that didn't take a lot of paid-in capital and the relationships that I had with those folks was really, really intimate. And, you know, one of those founders made close to 100 million dollars on it, changed his life, it changed, you know, uh, his family's life and, uh, as I went back to some other venture capital firms, like, you need another zero on that for that to matter. Like, when are any of these deals that you do are gonna, uh, are they ever gonna m- move the needle? And certainly it moved the needle for that founder and

2. 2:21 – 32:15

   Mega Funds

   1. RZRick Zullo2:21

      that was kind of like my Jerry moment of realizing there's an opportunity to go back to basics, do less companies. We have 15 companies at Alpha Fund.

   2. HSHarry Stebbings2:28

      You said unicorn investing is mostly dead for bigger funds and experienced VCs. No one is looking for a billion dollar outcome anymore. What did you mean by this, Jason?

   3. JLJason Lemkin2:40

      Well, I'll tell you, when I ... We were chatting before about things I learned when I started investing I didn't get, but when I started investing I remember one of my LPs, limited partners, came back, and this is probably nine years ago, from Founders Fund LP meeting, right? And this is a decade ago. And they came back and they told their LPs, who were stunned, that they're aiming for at least $100 billion outcome per fund. Now, this isn't today when you can look at least there's a few of those above that line, right? The, the ServiceNows and the Salesforce in B2B. This ... People's jaws dropped, but Peter Thiel obviously was the angel in seed in Facebook, so they'd had multiple hundred billion dollar outcomes and they drew a line and they said, "This is how the internet's growing (laughs) . This is how many people are using the internet. Over the next 10 years, we should be able to have at least $100 billion outcome per fund. That's what, uh, that's what these, these kids working for me are gonna go do." And, um, you know, that is still a, a slightly audacious goal in venture, but I think everyone has adopted one level below. You gotta have these $10 billion outcomes, and I do think everyone that's been doing venture for a while that is elite has at least one $10 billion outcome. That's what fuels these big funds, right? That and fees, as Rick alluded to, right? And other things. But one $10 billion outcome per GP, per fund can, uh, fuel, fuel the tank for a long time. That, that's what the goal is. And the problem is that b- that 10% of a billion dollar outcome is 100 million in a billion dollar fund. You're not even... Yo- you know, you're not... You're 10%. You're, you're barely... You're an asterisk, like we talked about. You're an asterisk outcome. You don't even count.

   4. RZRick Zullo4:05

      But I think this is one of the reasons why, like, structurally, like, you know, bigger funds at early stage are problematic. At a seed stage, it's extremely, extremely difficult to say, okay, here's gonna be a deck core verse, you know, a billion dollar. Like, yes, there are certain TAM constraints on some of these companies, but I think you talked about in one of the last round tables, Jason, about Talkdesk, that you were like, "Oh, this is, like, you know, our own company. It's a five nine. This is maybe a $150 million outcome and it's a $10 billion company." So I think, like, you know, the reality is, yeah, i- if you're a founders fund or if you're seeing these companies that have the chance to be a Snowflake or something else like that, I mean, the reality is, what? There's 20 companies in cloud that are worth more than $10 billion. There's a lot of companies that are worth a billion to 10 billion. If you're a later stage investor, being able to back up the truck on one of those is completely different than if you have to pick those at the seed or series A stage, yeah, u- I think that's a much more difficult situation to be in. And, you know, generally speaking, I think, like, that's the reason why I focus on getting into great companies and with... Hopefully they become $10 billion companies, but if you need them to because your math doesn't work, that seems really, really, really problematic to me.

   5. HSHarry Stebbings5:12

      Speaking of the maths working, I do just have to ask, when you look at the amount of two billion dollar companies, uh, sorry, two billion dollar funds plus that we have today, Jason, we did the math last time on what it takes to five or six X a $500 million fund. The maths to make a two billion dollar plus fund work is simply eye-watering. I guess my question is, what, what happens to these mammoth funds where there's now 10 plus of them? Do they reduce? Do they go away? Do they maintain and find new LPs? What happens to the era of mega fund?

   6. JLJason Lemkin5:44

      I think they're gonna reflate at the end of next year. I think there will be a resurgence of mega funds in late 2024 and 2025. I think we're all looking backwards. And we talked a little bit before about the flood of IPOs and the return of liquidity that's going to happen. The pendulum has swung the other way, right? That we, we... On 20VC there's so many stories of how hard it is to raise a fund and how LPs are, are cutting back. It doesn't last.... it doesn't last. It can't last, right? You're either in this asset class or you're not. So I know it may seem contrarian, but I don't think so. I think as, you know, 2021 was a great year for LPs, right? 2022 for some LPs actually was still great because of the l- time lag, right? You could actually have a great year as an LP in 2022 if you're finally getting your post-lockup distributions. A lot of folks had a good 2022. Some had it terrible, but it bled in, but when times are good, money will fl- re-flood into this. So I think we just have to be careful about drawing short-term conclusions when I actually see so many things getting slightly better. Like, slightly better, and it's really hard to see that curve, that logarithmic or parabolic distribution, but (inhales sharply) we wanna count them out, but I think we should count them in.

   7. RZRick Zullo6:52

      Yeah, I, I mean, I don't disagree with you that these funds are gonna keep on getting bigger. I think one thing that we could see is the maturation of th- this truly going from, like, venture capital to an asset management business, which if you look at the way that the Bridgewaters or Carlyles or those, like, yeah, they had core, kind of, you know, funds, and then they splintered off into strategies, and I think firms like, you know, Andreessen and Squar have already started doing that with their sub-strategies and so forth and having dedicated teams around those, that I think that'll start driving a little bit more rational math around, like, how do we go and return, you know, a fund that fits that strategy, um, as they start, you know, doing that across their teams. And I think we're gonna see more of that as the venture business looks more like an asset management business for those type of firms, just because, like, yeah, there's not that many $100 billion outcomes, and if you're gonna have one single strategy with a $5 billion fund, you know, you really need to be in those $100 billion outcomes, and, and that'll make that an incredibly competitive process. But I think the splintering off and professionalization of turning into asset management is really gonna happen in venture in the next couple years.

   8. JLJason Lemkin7:55

      Can I just ask a, answer a question you asked before? I'd love to get your thoughts too, right? I know you asked this version of this question a lot about multi-stage funds, coming in early, displacing seed funds. Instead of doing a two on ten, doing a ten on 40, or whatever the math is, I actually don't think it's new, s- at least it's not new for second-time founders, right? It's not new. Here's my thought back. So what? I mean, f- here's the, here's the cry me a river part. Founders, your job is not to run out of money. The problem is that they run out of money, and all this, the, the seed guys will say the problem with five on 25 is you can't raise the next round, you're, you're stuck, you're, you have a, you have a hostage, you know, huge fund won't write you a second check. It's all true. It's all true if your seed's at 50, it's really hard to raise the next round at 20, and it's all true that if mega fund puts the money in, they d- they see you as an option. But so what? Your job as a founder, if you got eight million instead of two million, is not to spend it all. Why are they spending it all? I don't mean to be patronizing, but I mean to be a little bit patronizing. As a founder, your job is not to run out of money, and where did this get lost in the, in the seed dialogue? Like, i- i- where did it get lost?

   9. HSHarry Stebbings9:00

      S- so I think if you can raise more money and operate with the mindset of having 20% of the money that you raised and putting the other 80% in a separate account and not spending that money, amazing.

   10. JLJason Lemkin9:12

       Yeah.

   11. HSHarry Stebbings9:12

       You should absolutely do that, and you should take the five on 25. But I've never seen anyone do that, ever.

   12. JLJason Lemkin9:18

       But why? Why don't the great founders do that? Th- I understand why the mediocre founders don't do it. I understand why they get, buy a Tesla and rent a beach house with the money. The great founders are going big. Why can't they use a spreadsheet and do the math and say, "I got a gift from heaven. Uh, I got four years of runway, and I'm not gonna screw it up." Why, why do, uh, why can't the best founders take advantage of this?

   13. HSHarry Stebbings9:38

       Because you can hi- you can hire more engineers. You can expand product faster. You can expand sales team faster. You can test multiple different marketing strategies at once in multiple different regions at once. (laughs)

   14. JLJason Lemkin9:49

       Yeah, but why run out of money?

   15. HSHarry Stebbings9:52

       Because you're doing all of those things. You are, you are, you are choosing speed.

   16. JLJason Lemkin9:56

       (laughs) You can't do the math? You can't figure out your zero cash date? You can't build a spreadsheet? You can't do a last four months analysis? Why, why, why can't you do these things?

   17. RZRick Zullo10:03

       Well, I think this is all because, like, you know, the assumption o- on capital being so abundant, and the reality is, like, a focus on growth rather than a focus on return on equity. And I think a big part of this is the investor steering in the wrong direction and saying that money is gonna be there. They're looking at a bunch of their peers and seeing the folks do the same thing. I mean, the amount of stupid things that, you know, us as VCs and founders have done over the course of the last four or five years is ludicrous. So anyone who grew up, you know, 10 years ago and had to go through hard times, I think they do appreciate that dollar. Anyone who didn't have money (laughs) before is looking at that, and yeah, they're managing their spreadsheets, like, very meticulously, but, you know, we all got a little high at the party, and the reality is, like, you know, people are paying a lot for that right now. I know it's definitely helped me think-

   18. JLJason Lemkin10:46

       No, we, we did. We did, and I blame the VCs at least as much as the founders, right? I, I, I f- it's stipulated 51%, 49, but the founder's, it's your life. I don't get why they drive the car off the cliff. Hooray, you raised, uh, at these inflated valuations, and yes, you overspent for a while. The fact that your business was declining 18 months ago, you should have seen it. You should have adjusted. You should have done something, or at least not run out of money. At least not run out of money, okay? This is like, you can go back to the dawns of venture capital. Rule one in 1784 was don't run out of money. It's John Doerr's rule. What excuse is there, right? I don't, I don't get why there's an excuse for running out of money.

   19. RZRick Zullo11:23

       I mean, Jason, I'd be interested to get your take. Like, d- did you ever have to do a RIF at any of your companies? Like, um-

   20. JLJason Lemkin11:28

       No, I took no salary for 18 months, okay? I invested my own limited money from my first startup and my second, okay? I did a lot of crap. I had no ... I went from a modest salary to none for 18 months. Um, I did a whole bunch of things. Uh, we, I stayed more efficient than I should have. But we didn't run out of money. If I, if I paid myself 250 grand and hired everyone and did every campaign ... No, I hunkered down. I focused on viral acquisition, which costs zero, and I paid myself nothing so I could hire a person and a half to replace me. That's what you do.

   21. RZRick Zullo11:57

       And how many RIFs have you been a part of as an investor?

   22. JLJason Lemkin12:00

       Listen, I know this may be triggering. I wrote this post years ago on SaaStr. If you're a great SaaS CEO, you should never have a RIF. It's called recurring revenue. You should have the ability to pl- now I get it in B2C or D2C or X and Y and Z to C. I don't think good SaaS CEOs should ev- I think it's an utter failing to ever have a RIF.... um, unless it's a quiet talent reorg, right? That's different. A 5% RIF to work out the bottom 5% and replace them with top performers is one thing, but no, you should never have a RIF. I never had one as a founder, and, uh, I think it's a, uh, I think every CEO should be embarrassed in, in B2B if they do.

   23. RZRick Zullo12:32

       The point that I'm trying to get at here is, like-

   24. JLJason Lemkin12:34

       Yeah.

   25. RZRick Zullo12:34

       ... your N of, of companies that you have with a founder are very, very small, and that RIF feels deeply, deeply, deeply personal. Like-

   26. JLJason Lemkin12:41

       Yeah.

   27. RZRick Zullo12:41

       ... the N of companies that you have as investor, I mean, th- the reality is, we've had to go through RIFs. Like, uh, you know, one of the things that we said over the last, like, 12 months is like, everyone's either RIFing or raising. The reality is, I think, when you've seen how productive a RIF can be, you know, uh, and right-sizing a company especially over the course, you know, you just pick up more data points as an investor that it, yes, it feels a little less personal. Those aren't people that you're working with on a day-to-day basis. But I think this is the reason why, like, there needs to be more, like, cut the shit between, you know, investors and founders, which, uh, we really moved away from that over the course of the last five, 10 years. Because, like, just like you were talking about, like, there's a lot of incentive to sell, uh, sell a founder, and a lot of incentive to be all about the NPS score, and everyone's trying to, you know, raise funds every 12 months so they need, you know, those founder references. When, I don't know, the, the best relationships I have with my founders, like, you know, you can go to bat, you can fight, uh, and, you know, get back to the table the next day because there's trust there. But that really moved away where it became a lot of kind of patty cake and, you know, how can we, you know, you never vote against the founder and you never kind of push back on the founder, and I, I do think, like, hopefully, like, this creates a more productive plateau where, you know, there can actually be friction between an investor and a founder to, uh, to arrive to the right point, because I do agree with what you're saying. Those risks shouldn't happen if your company is working, but the reality is there's no pushback and people kinda get lost when they're on a highway, like speeding up, and they don't see all the risks that are around them, and that's an issue. And that's should be your job as investors to help leverage the fact that you have a larger N of companies than a founder does to say, "Hey, like, you're doing something that is really concerning based on the other best practices." And people haven't done that for the last couple of years. I've seen in my own companies with other board members being, like, asleep at the wheel, not wanting to push back against founders, and founders need it too. Like, we, that's, we're all trying to make money together.

   28. HSHarry Stebbings14:33

       Jason, do you even feel you can, though? We've discussed it before. You just get put in the annoying investor or shithead box. It's a nice idea, Rick, and I like the idea of productive pushback. But I just find that I'm resented for it. I think Jason agrees with me. And so it's like, is it an idealistic state to wish that we go back for that, and do you not need a uniform consensus among investors? 'Cause if half say, "Yes, we're gonna push back," and half say, "No, we're gonna give you our money completely willingly and never say anything 'cause we just want good NPS," well, they'll just choose the good NPS.

   29. JLJason Lemkin15:05

       I'd love to be the first or second largest investor in a startup, but there's one I really love, I'm the third largest. Um, I'm not on the board. I'm not even an observer. Um, I'm the largest below that level, right? But I, but I, but I am reasonably close to the founders for a very long time, and I caught up with the, the largest investor. And I love everything about this company, but the burn rate remains very high. It remains 2021 high. And I said, "Just wondering, like, what do you guys chat... I don't go to the board meetings because what are you guys chatting about?" They're like, "It hasn't come up." "Uh, what do you mean it's come..." He's like, "I just don't know how to address it. I don't wanna, I don't wanna impact the relationship." I'm like, "Ugh, I gotta do it again." I'm like, "Okay, look here, I'll do it." (laughs) "I'm the number three investor, but put the Zoom together." And I brought it up, uh, y- but, but, but when I'm the number three my job is to just help, right? So I have, I brought it up with the founder who is an A+, a 10, but burning like it's 2021. The top line justifies it, right? But the bottom li- but the reality of today's world doesn't justify it. And it's been a year and no one wants to, to talk about the issues, right? I think we're still seeing these 2021, 2022 reverberations happen. In the end, people will have wished that conversation happened six to eight months ago. But every, uh, the, the tenor's changed, everything's changed.

   30. RZRick Zullo16:08

       But I think this is where it becomes really important about, like, who's around the table and what hats are they wearing. Like, uh, you know, y- you're the number three investor there and you're like, "Okay, I'm wearing the helper hat." But it-
3. 32:15 – 39:42

   How "Mark to Market" Corrupted Venture Capital

   1. JLJason Lemkin32:15

      markups, especially for smaller and other funds, has completely corrupted the industry.

   2. HSHarry Stebbings32:20

      Yeah.

   3. JLJason Lemkin32:21

      Venture would be radically different if there were no markups. It would be radically different, and I, and I'm confident it would be a better industry. I'm confident it would be a better industry with no markups, or at best, even though it's expensive and a headache, a conservative Black-Scholes analysis of these assets that would be annoying, but you'd sit on a 1.2X, 1.5X, 2X fund for a decade, and so be it. It's not that I don't think mark to market is, is... I do think it's telling. I think it's, it... I do think there's something to all of it, right? But it's corrupted behavior in a way that, that I don't think we anticipated. It's corrupted everything up and down the stack, right?

   4. HSHarry Stebbings32:55

      Wh- why?

   5. JLJason Lemkin32:57

      Why is it corrupted? It... Well-

   6. HSHarry Stebbings32:58

      Yeah.

   7. JLJason Lemkin32:59

      It's corrupted behavior because it's created an incentive to over-fund companies, to mis-fund companies. It, it... When times are good, it, it... You hear Rick and others saying, "Hey, let's keep companies properly funded. Let's, let's leave room for proper exits." No one gave, gave a heck when they got a markup, when they had a 5X fund and could raise another fund. Um, even less discussed is that a lot of LPs, big, at the bigger LPs, they're compensated based on paper markups too. This is less well-understood. They're compensated. This drove crazy... Where, where did all this unicorn explosion come from? People don't understand that the cash had to come from somewhere, right? It didn't all come from what's-his-name at SoftBank himself. And the fact that some LP, not, not most, but many LPs got compensated themselves on paper markups drove an endless round of markups too. The seed VCs wanted it because the seeds guys looked like genius for the first time. My last fund, in the first year, I had 140% IRR. That's moronic. No, but it, but it wasn't... It can't last. I'm not that good. You can't la- It can't last for 14 years. That's... Year one was the high, IRR high point of that fund, year one was the... It should be the other way around. Like, years eight or nine should be the higher point. Year one was the IRR high point, right? And so of course you get addicted to it, right? You want that, and it, and it, and it means raising too many rounds, too many rounds at too high valuation. Maybe we took a pause on it briefly, but that corruption's gonna come back. Every CVC wants a 4X or higher fund and a couple unicorns to sustain their business. Everyone wants it. Everyone says they don't, I think is lying.

   8. RZRick Zullo34:30

      But I think LPs are, are wiser to that now, Jason. I don't know.

   9. JLJason Lemkin34:34

      Yeah, but they don't want nothing. But they don't want a fl- a, a 1X fund forever, or a none-X fund. They sure don't want the opposite. Like, they say that, Rick, and I don't mean they're... They say that, but they don't want... I don't think they want the opposite. I don't think they want, "Oh, well, let's... All of them w- are gonna be sub-, uh, nine-figure exits, or all of them are dogs," or, you know, SoftBank, or whoever, Andreessen won't invest in any. (laughs) They don't want that either.

   10. RZRick Zullo34:55

       I think they want 10-bagger funds and they want trust. And I think the reality is, like, if they could be an emergence fund or a USB fund that has a 20-bagger, I mean, the returns of those funds are amazing. And I'm very, very confident that those didn't look like 140% IRR funds right out of the gate. Like, they took time to compound. But I think those funds have developed tremendous amount of trust with their LP bases, saying, "Okay, we're gonna let the game play out." Now, if you're an emerging manager, like, I certainly felt pressure on this on Equal One of like, okay, I wanna show our LPs that... You know, I wanna show the market, you know, that we're... You know, we have a great portfolio, so, you know, let's go and get all these markups. And, and that's really helped us. You know, that helped our reputation in the market, it helped our reputation with LPs. But at least at our last AGM, like, it, it was very, very frank discussion around, "Okay," like, "Do you guys trust us?" Like, "W- we may do less frequent fund raises. We may actually buy up more and be more aggressive with our opportunity fund to go out there." At least for us, our LPs were immensely supportive o- o- of that approach, unless they're not telling you, (laughs) but that's what they did. And I think, you know, the best LPs do think that. They're saying, "Hey," like...... you don't know what your portfolio is worth here. Like, what's your process that you have? Do we believe in that process? Do we believe in your team? Do we believe in your approach? And we're gonna see that play out and hopefully just be as transparent and, and demonstrate trust with us that we're gonna let that game play out over the course of these funds. But I think all the emerging managers that have come to the game over the last couple of years, like, we were all fighting for so much capital with each other. Like, a lot of those doors are now closed, and I think it's LPs figuring out, "All right, like, how much trust do I have that these people are not bullshitting me on these numbers? How much trust do I have that, like, these are actually high-quality companies?" And I'm hopeful that that actually gets us all a little bit off the hamster wheel 'cause, at least for me, I'd rather spend time, like, working and building the companies than raising rounds every six months. You know, there were times over the last couple of years that I felt like an investment banker, and that's, like, the last thing that I wanna be.

   11. HSHarry Stebbings36:46

       Do you think LPs trust their managers? 'Cause all the LPs say to me, "Hey, you know, book values are so varying. I've got one manager who holds it at 3 billion, one manager who holds it at 1 billion. I don't know where to put my books. I don't know who to believe." That all seems to suggest to me a complete lack of trust.

   12. RZRick Zullo37:03

       I think they trust some and they don't trust others. Like, you know, like, I'd rather sandbag and surprise to the upside than be in a position where I've overpromised and under-deliver. Again, maybe that's the middle class, like, you know, m- middle childs (laughs) you know, you know, in me. But I think, you know, underpromising and overdelivering is a great way to, you know, restore a lot of trust with LPs. And, like, we've generally turned down, like, capital into our fund and kept our fund size as reasonable. That way, like, we could have a smaller LP base that we felt was more trusting. We try to be super transparent with our LPs about what's going on. Uh, I'm sure there'll still be lumps that we take in our portfolio that we don't see, and that's bound to happen. But I do think that there's a lot of distrust in especially, like, very big portfolios or when someone sees 100X markup and no revenue behind it. 'Cause some of these companies that have zero revenue but a several-billion-dollar valuation, like, that's a very, very tough situation to justify that this is gonna ... Especially in the really, really hot stuff like, you know, everything in AI, you should probably be taking some discounting on those rounds.

   13. JLJason Lemkin38:04

       Most funds, I mean, when you're big, it's different, but most funds that aren't huge have a few core anchors, right? They really do. And typically, those relationships are trust-driven, right? They, they are trust-driven. That's why they're anchors. The rest, it is transactional, and LPs should be suspect. There's, there's suspect GP behavior. There's suspect CEO behavior. I think this suspect GP behavior is more subtle. It's overstating things. It's exaggerating your role with companies. It's dra- connecting dots that don't quite exist, uh, in terms of ownership and stake and time. 2020 to '21 was a weird world. It's hard for all but the best funds to raise LP capital. It has swung back to being hard as it historically was, right? It traditionally took two years to raise a fund, not, not an email. And so that naturally leads to everyone trying to be, uh, uh, ch- trying to be as aggressive with the facts as they can be and LPs seeing them as a product. It's, it's a complicated, it's a complicated relationship. It's a complicated relationship. You know, I just met with a great LP that I have who has been a bit of a mentor to me, uh, at least a little bit. He was thinking about dropping a top-tier fund because managers had changed, and they hadn't been properly communicated, and he wasn't sure what would happen with the next generation of the fund, right? There's just lots of dynamics, and it's very hard to be an LP. It's an easy job in that it's very, very slow, but it's very hard to get good at it, right? It's very h- it's the- it's the- it's, it's wh- it's, it's another order of magnitude slower feedback loop than venture, which is, which is pretty slow. (laughs)

   14. RZRick Zullo39:29

       I mean, you, you do hit on something that's really important right now on this, Jason, is that there's just been, like, such a focus on salesmanship across the entire venture ecosystem. It's like-

   15. JLJason Lemkin39:38

       So much salesmanship, yeah.

   16. RZRick Zullo39:38

       ... founders pitching at YC Demo Day.

   17. JLJason Lemkin39:40

       So much salesmanship.

   18. RZRick Zullo39:40

       It's GPs, like, pitching as

4. 39:42 – 50:31

   The Pitch vs Substance

   1. RZRick Zullo39:42

      much as they can. Let's just cut through the sales for a second and actually just, like, have substance, which I think relationships being able to form more naturally. Like, one of my mentors is an LP, and just that's been a very long-term relationship that I think that they've been able to see us develop. A lot of the founders that we work with, uh, and I haven't taken a pitch in eight years because I think pitching is bullshit, because I think it's all about sale- salesmanship and rather than actually, like, me understanding your understanding of a company. And I think if we all did 10% less sales and actually 10% more substance, everyone would be a lot better off.

   2. HSHarry Stebbings40:14

      Jason, do you agree with that in terms of the pitch? 'Cause I know you like an email that's, like, very structured, has everything, has a deck, has a lot of substance. I thi- I feel like you like-

   3. JLJason Lemkin40:23

      I thought Rick was maybe ta- With Rick, were you talking about LPs, or were you talking about founders?

   4. RZRick Zullo40:26

      I'm talking about up and down the entire, like, uh, when we went out for f- fund one, our pitch was terrible. Like, I, I, I, I won't say which fund of fund, but one of my friends showed me the notes in their CRM from ... And they're like, "This pitch sucks." Like, doesn't make sense, da, da, da, da, da. And I was like, the LPs that we ended up resonating with, they took time to understand us. They realized that we sucked at pitching and really got, you know, on board with the story and the process. Honestly, that's the way that I resi- I don't like... Those are the type of founders that I like. I don't like a pitch. I just wanna understand them and see how they work, you know? But-

   5. HSHarry Stebbings40:56

      I see.

   6. RZRick Zullo40:56

      ... I do think that this overselling across, like, founders selling GPs, GPs signing LPs, everything feeling like it's a demo day, I think it kind of takes us away from what we're supposed to be doing on the field and actually makes us just obsessed with, you know, pitching all the time.

   7. JLJason Lemkin41:10

      I see your point. Yeah, I actually do. Harry's right. I do really like it when the founder is good at pitching. Um, I like it when the first email is so good that you wanna invest by the bottom of the email. I like it when I'm already want to invest before the Zoom starts. I want to invest e- whe- before the minute I meet them. And it, and you miss stuff. You would have missed Rick's first fund. You would have missed these other founders, right? Um, and I was o- you know, I did this, I did this catch-up with the monday.com founders the other day, and they showed me the e- the pitch email they sent me. It was the worst ever when they were starting. It had a different name. It was terrible. It's like, "We're thinking about doing something in productivity. Would you like to talk?" Okay? And it was, and these are the best guys in the world, and so I didn't take the meeting. Not that I lost... I didn't even take the meeting, f- forget about passing or missing it. So you'll miss the Mondays by this approach, but you gain a ton of efficiency 'cause in B2B you gotta sell, man. No one needs another SaaS product. We already have 11 payroll companies and 88 CRMs and 96 mar- We don't need one, so if you can't f-... force your way into a market. And selling stock is sales. It's a weird, niche-y sales but you better be good at it as a founder. So I like the ones, not that are used car salesmen, but I like the one that are new car salesmen. Like, they convince me there's a Model 3 that came out of nowhere and I gotta buy it and I'm, I'm all in. Like, I'm all in when I see that.

   8. HSHarry Stebbings42:26

      I'm just like, you know what? As a founder, you, you have to pitch and you have to be fucking good at pitching 'cause you have to sell customers, you have to sell investors, and you have to sell employees. And actually, if you can't crisply articulate it e- to, to all three, you're in trouble. If you can't get the cash in the door, you're in trouble. If you can't get the customers in the room, you're in trouble. If you can't get the engineers or employees in the room, you're in trouble. So if you can't pitch well, succinctly, and get people on board with your vision and they need time and they need patience, I think your likelihood of winning is dramatically reduced.

   9. RZRick Zullo42:57

      So I would say, like, when numbers do your talking for you, that pitch is so much easier, which o- o- the two biggest drivers in our fund, the, the pitch at CCH for both those companies was extremely problematic. And those companies have now gone on and raised a boatload of money from, like, top, top, top, top tier VCs. We were able to work with them to improve their pitch and know how to do a fundraising process. And so both, both times, first-time founders. But I do think that pitching is very much an art form that Silicon Valley, like, has embraced. Like, it's very much in this Don Val- uh, Don Valentine archetype. And yeah, there's people that all they do is practice pitching and they forget how to run a business.

   10. HSHarry Stebbings43:34

       (laughs) .

   11. RZRick Zullo43:34

       And I do think salesmanship is one thing, but like, if you're selling to the insurance industry or selling to, you know, uh, a rig hand or, you know, or a truck driver, that's very, very different than selling to, you know, a s- a, a, a venture capitalist. And I do think, Jason, what you do, like, very locked into a certain type of sales process around selling to CIOs, t- CIOs, s- CIOs, CTOs, enterprises. Like, you understand that 10 times better than I will ever if I spend the next 20 years of my life focused on it. But I do find, at least in what we do where the customer bases are very different, we just haven't seen a lot of correlation between the folks who are, like, really great at raising money at the seed stage and the folks who are really great at building a business. And the people who are really great at building a business, they get pretty good at pitching over time too, so.

   12. HSHarry Stebbings44:18

       Yeah, but I don't think the pitch always has to be positive. Like, a question that I like to ask is like, "What are the top three reasons why I shouldn't invest?" And if you can clearly articulate the three biggest weaknesses and why they are challenges, but then maybe articulate a plan of how you plan to mitigate them, that shows incredible self-awareness, it shows incredible knowledge of ecosystem of your own flaws. That's not like pitching and the salesmanship were great, but it teaches me a lot about how you think strategically as a leader about positioning, about your own flaws, about resource allocation. So I think we c- like, connote success and salesmanship with pitching, which is like, you can pitch and still present challenges. I love it when a founder's like, "Oh my God, there's so many things on fire. We've g- run out of SDRs. We're spending too much on Facebook." But there's this crux of this brilliance that's working. I still think that's incredibly exciting. So I think there's more to it than, like, positive pitching.

   13. RZRick Zullo45:11

       It, it depends how much gamification is happening, right? So, you know, if someone knows that you're gonna ask that question, someone's gonna prepare for that question. It's like, you know, the, the, the way that people are preparing for the GMAT. Like, is it really a test of intelligence when you know a- a- i- if you, you know, spend enough tra- uh, time training to answer a certain type, like, are you gonna get good at it? Like, the answer is yes. So a- at least for my approach, which is different from other members of our team, this is just me, is the reality is like, I review your deck. I actually know the four or five key questions to get me to conviction. And I come in there and like, I spring on the founder, "Hey, we're not gonna do a pitch. I wanna talk about these four or five things. Like, here's what n- I need to get to conviction, like, let's go." If they really understand their business, they're gonna be able to ta- ta- talk through this. If they don't, they are gonna completely like... it's a bad meeting very, very early.

   14. JLJason Lemkin45:56

       I- i- if you're a seed investor, um, th- it is absolutely true that at some point as a founder, you will get good at pitching in VCs, uh, investors. And maybe when you're a public company because still are gonna be pitching investors as a public company all the time, so you're gonna do spending one month out of three pitching investors, or just different. Or you might get good at it when the numbers are perfect at the late stage, or some folks get really good at it before demo day, right, if they're well-trained. I do think Rick's got a good point that, that, you know, the Monday example is just so fun. You're not p- p- pro- people aren't necessarily born great fundraisers, right, or g- or even great sellers, right? Most founders are born great builders, like we build products. And the question is, do you wanna d- put in the energy to cut them the slack? Because what I do takes no energy, right, to judge somebody by their email. It does cut out education bias and a bunch of other, and country bias, but it doesn't cut out, you know, sell your vision well bias, right? If his two best investments are s- ones that had terrible pitches and no traction, you gotta put in the time. Like, you gotta really meet a thousand (laughs) companies a year. And I have, I only actually, I'll, I'll read a h- 50 emails a week but I only wanna do one pitch a week. I only... if I can, that's my dream. And I find when I do two, three, or four, the other three aren't worth it. And then I gotta follow up with an email and I gotta explain why and they don't listen and it's like 11 emails. And I never should've done the third or fourth meeting because it was on the bubble, right? So you gotta do 50 to do this strategy. I- it's respect, it's respect.

   15. RZRick Zullo47:18

       J- Jason, you wanna hear something absolutely insane?

   16. HSHarry Stebbings47:20

       Yeah.

   17. RZRick Zullo47:20

       I take, like, on average, one new founder meeting a week. Uh, and, and, and so-

   18. JLJason Lemkin47:25

       Okay, well, you boiled it down. For better or worse, right?

   19. RZRick Zullo47:27

       Well, yeah. So, so at least for us, like, we are so meticulously thesis-driven that I rarely try to down-select and, uh, there's this bar that we have that is like, does this deal have the potential to change your life? If not, pass. Like, and like-

   20. HSHarry Stebbings47:41

       Yeah. How do you know that? Because like, bluntly, you know, your monday.coms, your Pipedrives, your sa- like, Sales Loft, if you saw the pre-seed or seed, like no offense, Jason, I don't think it would've like, "Oh, this could change my family's life with the grand vision of Sales Loft." I, I don't know. Do you know what I mean? It's not that obvious.

   21. RZRick Zullo47:58

       So, so here's my mental model around it, and it's probably a broken one but it's the only one I got. One, does this have the chance to be such a-... FU big outcome that, like, it's going to completely, like, return our fund five, 10 times that, like, you believe in your heart of hearts that it's an uber-sized outcome with decacorn potential, that you see that so early that you cannot miss it. And that's a, a, a meeting that I need to take. Two, you know, we have a process that we call hunting. Like, we have our top 10, 15 ideas on our big board that, like, I am laser focused on finding companies related to those, and screening for the quality of those companies, and our team screening for the quality of those. So if it's an idea that I feel like I need to flip the card, like, you know, Roger's talked about this. For Trade Desk he was like, "I needed to flip the card on that company because it was a thesis that I'd thought about so much, and I just like couldn't live with myself if I didn't flip that card." For me, like, flipping that card changes my life. Or third, is it one of these founders that you believe that has the chance to be like truly once in a generation, that is that exceptional, you know, in a very objective way? Not like a good founder, but someone who has the chance to be absolutely that insanely good. And at least for me, like yeah, we miss a ton of great companies, a ton of great companies. But if you find screening that down and really focusing on like, "How can I win the best companies that are the best fit for our approach?" We have a company working in our office right now, and the founder sold his last company for over a billion dollars. I spent six months courting this founder, it's in a thesis that we freaking love, and now he's billion w- you know, we are double digit owners of that business. And I'd rather spend my time working on that than, like, taking 25 pitches and, like, you know, just like hearing the same thing over and over 'cause that's, that's how I have fun, but it's definitely not the same for everyone, and I think there's multiple different ways to do this. Just try and do it a little bit different than everybody else, I guess.

   22. HSHarry Stebbings49:44

       I, I, I just, I did The Memo, which was a show where we interviewed, uh, lead investors of amazing breakout companies, and we did, you know, lead investor for Snap, the lead investor for Twilio, the lead investor for Instacart, uh, for 10. And the single commonality of that investing thesis was we all underestimated the size of the outcome. Yeah, we thought Snap would-

   23. RZRick Zullo50:04

       Yup.

   24. HSHarry Stebbings50:04

       ... be like a 300 million exit to Facebook. Twilio, like, I mean, and Byron was like, "Oh, we kind of had no idea." I mean, honestly, it could've been something that Salesforce or Oracle buy, but they were consistently like, "We thought it could be interesting and picked up for a decent amount." But the size and enormity of the exit was deeply underestimated. And so I don't know, dude. I, and I mean this nicely, I just really struggle with that first one of like, oh, I can tell the FU size

5. 50:31 – 1:06:49

   The Heuristic VCs Forgot

   1. HSHarry Stebbings50:31

      'cause I think you'll miss the biggest-

   2. JLJason Lemkin50:32

      You know if, something we forgot about, Harry, when, when I started investing I was taught this, this very simple heuristic or hubric and then we all forgot about it. When I was taught when I was investing, when exits were all small in SaaS when I started 2013, 2014, there were no... HubSpot IPO'd at 800 million, like, there weren't these big outcomes. So I was taught this simple thing, distilled it all, and it sounds so tactical, but are you confident the next round will be 3X this valuation? If you're confident, do it. It solves for a lot of issues if you slow it down and think about it, right? Do you think it might be worth more? Well, every VC (laughs) that doesn't have deal flow thinks it's gonna (laughs) be worth more, doesn't have good deals. But are you truly c- forget about what, whether SalesLoft's gonna be worth two and a half billion in cash, which didn't know, or Pipedrive a billion and a half or Algolia, whatever, didn't, didn't know to the, to the, to the Byron point. But I was confident for a variety of reasons they would be worth 3X the price. And, and this all got blown up with crazy valuations, but it does force you to break it into one atomic unit, right? Which is, is this company doing enough good things, right, with enough good founder and enough things so that you're gonna have not even a 2X, a 3X outcome. That was what I used in the beginning of investing, and now thinking about it live, I regret that I moved away from it (laughs) because it, it, it actually forced the r- a, a pretty decent way of thinking. Yeah, I'm 100% like, "I don't know what's gonna happen with Pipedrive or Algolia or Talkdesk or SalesLoft, but shoot, I'm, I'm pretty sure we're gonna, uh, the next round, like, pretty good founders, like, I don't know about this Twilio, this Talk API middle in there, but 3X, yeah. Like, yeah." You know? And if every investment's 3X, as dumb as it sounds, you'll have a 3X fund, right? (sniffs) That's pretty good.

   3. HSHarry Stebbings52:04

      I, uh, I, I totally agree, and then I think the, the other landing is like, you know, a lot of people say, "Well, you know, different people, different r- approaches." And then a lot in Europe people say, "Well, it doesn't matter, you know, you don't have to get them all." Actually, you do, because there are not many at all. When you look at the companies over 10 billion in Europe as an example, you know, you've got Spotify, you've got Adyen, um, you know, Revolut is valued over 10 billion. But the idea of like, oh, you don't have to see them all, even in the US, like, there's very, very, very few that are over $10 billion. You kind of do need to have coverage play now, because the enormity of exit is much more realistic and I think about that a lot more now. How do you guys think about that?

   4. RZRick Zullo52:46

      There are plenty of 10X funds that haven't ever been at a decacorn. And like you, I think Roger probably has a couple, old mucker has a couple, you know, um, Tim Connors has some monster funds that like, you know, certainly some big dri- drivers in there. And then you look at funds like Emergence and USV that have had, you know, massive, massive funds, and certainly they have some decacorns in there. So I think you're right that that first one of "this will change my life," it is really, really, really hard to figure out what is gonna be a massive company at the seed stage that, you know, plenty of people have haircut things and was priced to the upside. At least for us, we look for the ideas that we think are gonna be a really transformative industry, and I am not gonna guess what's, what's gonna happen in the long term outcome, that hopefully they have flight path to a $10 billion company. Like, there's definitely TAM in all these industries to be able to do that. But companies can screw up a thousand times, you know, or along that way, that cuts that path short. So I think like the, the scary thing about venture is when you really cut yourself off that, like if you're a European seed stage VC and the only way you can win is if you have Spotify, that is a really, really tough position to, to be in. If that's the only way you can 3 to 5X your fund, you know-... chances are, is that you're not gonna succeed and then you're gonna lose to guys like you. I mean, you got a way better chance to get in that than 99% of the other, you know, VCs that are out there but, you know, our job is to go and find ways to make money and, and I think there's plenty of private equity funds, growth equity funds, you know, that have found ways to deliver 40, 50% IRRs to their LPs without being inside those. It's just like when you get on such a big fund cycle that you're required to do that. And look, we, we have a unicorn in our portfolio, we got a bunch of companies that look like they'll, they'll, they'll, they'll get there. You know, I'm hopeful one of those turns into decacorn but I think when we force a company that, like, rightfully is not going to be a decacorn company down that irrational path, it's like flushing money down the toilet that, that it's like, okay, maybe we can actually get this to a $500 billion company, let's actually figure out once we're in there, like, do, is the founder gonna scale? Is this gonna have the potential to do that? Like, wait, I only own 15% of this thing and if we could sell this thing for a couple $100 million 'cause we know it's not gonna be a decacorn, yeah, there's a couple of companies in our portfolio that I'm like, this, if this, if we have a decacorn in our portfolio, it's gonna be one of these three or four, uh, and we know the ones that are not gonna be there and, you know, trying to make sure that we can make as much money, uh, from them as we can.

   5. HSHarry Stebbings55:09

      Okay. Uh, Jason, do you have anything to add before we do a quick fire?

   6. JLJason Lemkin55:12

      Thinking through it, I think there's two ways to build a, a unicorn plus. You can stairstep it or you can, you can swing for the fences from the start. And the swing from the fence is you can, you can have the perfect idea and, and thesis and make sure it's a large space and make sure that there's a, a $50 billion TAM accessible, or you can stairstep and you say, "Look, am I 100% sure or 90% sure there's gonna be a 3X to the next round?" And just w- thinking on it, I think I've done better stairstepping personally. I've done better stairstepping than white boarding. I've done better... Now, stairstepping does force you to be more valuation sensitive which is maybe why a lot of us abandoned it. Like, it's hard to stairstep from 100 to 300. It's much easier to stairstep from 15 to 45 or 10 to 30. And when we all lost discipline in the peak, maybe we all stopped stairstepping and looked for markups. The Twilio example or even, um, you know, even Shopify. Bessemer exited Shopify, they didn't know, right? You gotta stairstep some of these, some of these ones. And, uh, maybe that's the back to basics is founders should... Founders don't do this anymore, Harry and Rick, I don't think. If I wanna be grouchy about something, they don't raise a round and say, "Am I 100% sure? I'm gonna 3X it," 'cause they shouldn't take the money. Like, slow it down. If you're... And I literally had a founder the other day who had an offer at 450 and just turned it all down for the first time in the history of this company. And I asked him why, he's like, "Uh, um, the 3X math, it's not worth it." (laughs) It ain't, it ain't worth it so slow it, stairstep as founders, make sure you can stair... Your life, your f- your VCs may pressure you on this but if you triple their money, everything works out for everyone on the cap table, right? It may not make the fund, it may not, but if everyone... 3Xes, it's enough and so stairstep your li- and I do think you can build unicorns and large funds stairstepping and that's what I wanna get back to, right? Is stairstepping deals, just stairstepping 'em, right? 20 million post, fine, but I gotta know it's gonna be 60. (laughs)

   7. RZRick Zullo57:01

      How do you feel about that in this market though where, like, seed sales are absurdly expensive and As have definitely depressed in value? Now, like, I mean, it, it, i- i- I would almost wonder whether you're seeing some adverse selection in there like-

   8. JLJason Lemkin57:12

      You always can say that.

   9. RZRick Zullo57:14

      ... yeah.

   10. JLJason Lemkin57:14

       A- a lot of these investment strategies, everyone will say there's adverse selection. When I started investing in European founders, some folks I invested in said, "Don't even tell the LPs that's, you're doing that because it shows you don't, you can't get any Americans to invest in." Well, you know, I wouldn't have done Algolia or Front or Pipedrive or Gorgias or others if I was prejudiced against Europeans, right? I wouldn't have even met Harry because I would've been too bratty, I guess, I don't... And so, yeah, there's a lot of the, but this adverse selection thing, I think you can take it too far because you wanna find the undiscovered gems. The adverse selection ignores the undiscovered gems. The adverse selection focuses on the eight guys from Stripe, uh, the eight white men from Stripe that have the perfect Stripe 2.0. That's what positive selection gets you and, uh, works for big funds, right? Adverse selection.

   11. RZRick Zullo57:55

       I think we've swung from, like, decacorn hunting to, like, okay, like, you know, maybe Jason is in the back to the basics, like, you know, camp no- you know, now.

   12. JLJason Lemkin58:02

       But I think Harry's got the point from the memo which is you can stairstep your way to an epic outcome. That's what we lost track of. You can stair... It's not mitigating risk, it's just stairstepping, uh, the way and not, uh, and, and keeping life simple, right? Just making sure genuine... You're co- as an investor and as a founder, you're just ultra confident you can triple that value, um, or you raised 'cause you have no choice. That's always okay. (laughs) Like, if your back's against the wall, then just get the deal done but...

   13. RZRick Zullo58:31

       No, I mean, keeping life simple is actually really hard. It, like, it requires a lot of work, a lot of discipline, keeping the options open because you're alive long enough for like, things to magically happen and, and that's the reality of, like, okay, there's a lot of hard work that goes in at these early stages that all of a sudden doors open and, and that's when you gotta take your shot which I think as a early stage VC it's, all right, how can you get enough really high quality shots on net on the field? Get those companies to product market fit, get them to early stages of scale, do all those hard things. And then at that point, hopefully you own a ton of, you know, some companies that actually have the chance to, you know, ascend to greatness but you gotta also be really draconian with the portfolio and say, "Okay, like, can I get a couple turns of my fund on some of these other ones, you know, that aren't going to ascend to a te- decacorn type outcome?" But you've kept it alive and gotten enough ownership and done the hard things, you know, through that time and I think that really gets thrown to the wayside when, you know, you're looking for a decacorn between seed and series A. That decide, you know, the stairstepping I think is better for founders and it's better for, for investors. It just gets really, really hard when people don't have patience in the ecosystem or like, "Wait, if I need to get my next round down by Sequoia, this isn't gonna be the one." And turns out that Sequoia didn't invest in every single decacorn company. As Harry was saying, sometimes it takes a little bit later.

   14. JLJason Lemkin59:47

       Harry, how many, how many... I know you, I know we're almost done but how many meetings do you do a week?

   15. HSHarry Stebbings59:52

       With new founders?

   16. JLJason Lemkin59:52

       How many do you think... How, or h- and how many get close to a meeting? How many do you do a week?

   17. HSHarry Stebbings59:57

       I do three new founder meetings a week. Um...

   18. JLJason Lemkin1:00:00

       Three?

   19. HSHarry Stebbings1:00:00

       Team Kieran, my partner, does 35.

   20. JLJason Lemkin1:00:03

       Okay. So he-

   21. HSHarry Stebbings1:00:05

       So-

   22. JLJason Lemkin1:00:05

       ... helps with the funnel, he helps with funnel management, right?

   23. HSHarry Stebbings1:00:06

       He really helps me with leverage, and then I do two to four, generally sits at three. I think honestly for me, that allows me to be super researched before I go in, and know ex-

   24. JLJason Lemkin1:00:17

       Yup.

   25. HSHarry Stebbings1:00:17

       I hate going in where you don't know anything, you haven't seen the deck, and you're kinda going, "What's going on?" I wanna know what I'm doing, I wanna know the story, I wanna be ready to go with questions. Honestly, I can't do that with more than three and provide a great customer experience, and so I like to cap it there and provide a good experience to viewers.

   26. JLJason Lemkin1:00:36

       This is the kind of stuff that people don't reali- I mean, you can't do 50 meetings a week, no matter what they say on the internet. You, you can't, you can, you can show up with no work, you can show up with a cup of coffee. (laughs) You can't really do the work for 50 founders a week, right? You can't really do 2,000 meetings a year, right?

   27. HSHarry Stebbings1:00:50

       Oh, that's what board meetings became, you know? No, who-

   28. JLJason Lemkin1:00:53

       Yeah.

   29. HSHarry Stebbings1:00:53

       ... who has got to see the 20-page board deck when you're on 16 boards?

   30. JLJason Lemkin1:00:56

       Yeah.

Episode duration: 1:12:29