Episode #95: The Fool's Gold Problem, Dario's "We Must Pace the Frontier"

Charles Hudson (0:00)

But I do look at this and just say, everything right now in AI InfraLand seems to be pegged towards a world in which the Frontier labs have endless access to capital and endless appetite for compute. And in a world where that gets moderated a little bit, the ripple effect, I don't think anybody in Ventures ready for what it would mean when the happens. And I have to believe that to some extent, if I were to one of those companies that, well, we're continuing to push the Frontier, our models are getting better faster than the average customer we have is able to generate positive ROI from these things. So maybe if we slow down, actually gives our customers also a chance to catch up.

Mia Farnham (0:42)

It's the week of September 14th. Welcome to The Learning Corner, a Precursor Ventures podcast.

Welcome to The Learning Corner by Precursor. I'm Mia Farnham and I'm joined by our cheeky and managing partner Charles Hudson, where we will be talking about the articles and good reads that caught our team's attention over the past week. We're going to do something different. We'll do two articles today because the second one is obviously going to be the focal piece of this week. But for our first piece, this week comes from Gil Dibner, GP at Angular Ventures titled Raising the Bar, Inception Stage Venture in the Age of Consensus. Gil argues that venture has barbelled into two extremes, a tiny set of hyper consensus companies that can raise endless capital at any price. And everyone else who now faces Series A graduation rates that have been falling since 2021, his sharpest line in that piece is that the vast majority of the market is systematically paying pure gold entry prices for fool's gold companies, and that the true N of one founder worth paying up for is far rarer than anyone wants to admit. For the non-consensus side where he says most of the seed funds capital and conviction belongs, he lays out three distinct bets a founder can be unwriting. Fund to break even, fund to fundraise, and fund to fund again, and warns that miscategorizing which one you are making is a recipe for disaster. The portfolio mouth he lands on is also pretty striking. A seed fund that used to make around 24 investments expecting a 50 percent graduation rate should probably make 40 and expect 10 to 25 percent in a graduation rate, while ruthlessly cutting defensive follow-on reserves, closes by borrowing from a quote from Jerry Colonna, what if the real work is learning to hold contradictory truths at the same time?

I want your general feedback to the piece, but one that stood out to me from Gil was Gil's answer to plummeting graduation rates is more shots on goal and fewer defensive follow-ons. So essentially 40 checks instead of 24 Does that math feel right for you? And then like, where do you draw the line between being strategic versus spraying, which is obviously a critique of early stage venture.

Charles Hudson (2:45)

I think spraying is what other people do.

And so, as someone who's always had a big portfolio of construction, I chuckle every time I read these things. I go, it's almost as if it's always true. But I do think we've been doing a slow motion version of what Gil describes over the last four years. Basically, because I've been telling our LPs for almost the better part of half a decade that graduation rates from their 2021 peak are going to come down. I thought they'd come down to 25 percent. I told them 25 percent, they all freaked out. They're like, oh, cool guys, it's supply and demand.

Mia Farnham (3:18)

I think it was 18 reported.

Charles Hudson (3:20)

I think it's going to probably settle somewhere in 10 to 15 percent, which means most companies that get started won't graduate. So we've always been kind of a 20 percent reserves firm. A lot of LPs said, you don't have enough reserves for your winners and blah, blah, blah. And I'm like, well, at the early stage, if you get in at a good price, like the dilution math should be fine. So I think concentration is very hard to pull off in this environment. And I think reserves are very hard to deploy. And one of the things that I've lived through in the last five years is, I think for a long time founders associated being founder friendly with having money to do bridges, extensions and follow-ons. And every year I've gotten more direct and more harsh with our founders about, this is the bar for second checks. What I tell all the time is the first check is pure optimism. We both believe it's going to work. And the second check has to be informed by realism, has to be informed by like, well, what have we actually learned about the founder, the market, the problem, the competitive landscape? And in many cases, my conclusion is I would rather fund a brand new company where no cards have been turned over. And the percentage of defensive follow-ons that we do has come way down. And I don't even know that we're done yet. But part of that, if you're going to run that portfolio of constructions, you have to be comfortable as the GP telling a founder that you really like, no, that like, I don't have more money for you. And here's why.