š§š Peter Walker on Startup Valuations, VC Dry Powder, New Bubbles, and Employee Trends
Inside the emerging manager fundraising landscape, why Seed valuations are up 40% from 2022, why startup employees aren't exercising their options, and the impending SAFE reckoning
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Episode description
If you donāt have time to listen or read the transcript below, my biggest takeaways:
Despite the massive correction in the venture market, valuations of seed stage startups have actually gone up 40% since Q1 of 2021. Peter and I conclude this is due to larger funds moving from investing large checks (say $50 million) at later stages to smaller checks ($5 million) at early stages. They typically see these as option bets for their later stage portfolioās, so valuation doesnāt matter as much to them. Since these types of checks only go to the most consensus founders, fewer rounds are closing at higher prices, pushing up valuations across the market.
AI startups are getting higher valuations, but not as high as youād think. AI startups that closed Series Aās in Q4 2023 had an average valuation of $50 million compared to $39 million for non-AI startups. This of course doesnāt capture the revenue multipleās theyāre raising at (AI startups are probably a lot higher), but the valuation difference wasnāt as high as I expected.
Peter thinks thereās an impending SAFE reckoning. SAFEās are simple to raise money with, but can be challenging to keep track of if not kept track of accurately. Heās starting to hear from VCās theyāre concerned founders are selling too much of their companies early on because of this.
Down rounds were 2x more common in 2023 compared to historical years. This shouldnāt surprise anyone whoās paying attention, and my guess is 2024 will be another record year.
Almost half of all Series A rounds were extensions. Another surprise, but does make sense. If you raised a Series A in 2020 or 2021, you still might need time to grow into a healthy Series B.
Most co-founder ownership splits are not 50/50. Despite common perception that the split should be equal, there is typically one founder who has majority control.
The number of employees exercising their options are down 50% from highs in Q4 of 2022 and are now at record lows. On the surface, it indicates employees arenāt confident in the value of the startups they work for.
What happens if AI enables startups to raise drastically less money? Since a large majority of the āventure capitalā asset class is actually invested at later stages, not at the inception stage, it could have significant supply / demand implications in the growth market. (Personally, I donāt think this happens, and founders will always raise if it makes sense). This would make the most consensus rounds even more competitive.
Timestamps to jump in:
00:00 Intro
04:50 Valuation trends in 2023
08:10 Why Seed valuations went up over the past two years
12:27 AI startups are getting higher valuations
17:40 Why Biotech might be the next big bubble
19:15 Boston as the 2nd largest VC ecosystem
21:15 How SAFEās work
24:06 The impending SAFE reckoning
26:13 Why startups donāt pay investors dividends
28:31 Down rounds were 2x more common in 2023
32:11 Almost half of all 2023 Series As were extensions
35:34 Is there really a lot of dry powder?
40:43 The emerging manager fundraising landscape
48:19 Exit environment
51:45 Why pre-Series B is the most common acquisition stage
52:47 Liquidation preferences & why an acquisition at Seed might make a founder more money than at a Series B
55:59 Compensation market data
56:38 The number of total startup employees shrank in 2023
57:38 Why startup employees arenāt exercising their options
1:00:57 Health of the secondary markets
1:04:51 Most co-founder splits arenāt 50/50
1:06:47 Why you should always vest co-founder equity
1:09:30 2023ās record year for startup shutdowns
1:17:19 Will other startup ecosystems ever catch Silicon Valley?
Referenced:
Peterās Newsletter, Data Minute
Find Peter on Twitter and LinkedIn.
š Find on Apple and Spotify
Transcript
Find transcripts of all prior episodes here.
Turner Novak:
Peter, how's it going?
Peter Walker:
Turner, happy to be here, man.
Turner Novak:
Welcome to the show. I wanted to start things off. You work for Carta. You're the head... What's your official title?
Peter Walker:
Head of Insights.
Turner Novak:
Head of Insights. You have this very interesting, - insightful - newsletter that people should definitely subscribe to. We'll throw a link in the show notes.
Peter Walker:
Thank you.
Turner Novak:
I mean, you do this a couple times a week, just LinkedIn, Twitter. You throw out data. You create insights out of the data that you're seeing on the platform.
Peter Walker:
It's like once a week for the newsletter, and then probably an extra three or so graphics on social, primarily LinkedIn, so a lot of data being slung around.
Turner Novak:
I think it's a couple weeks old at this point, but still pretty fresh. The Q4 market report that you put out just based on all the data that you're seeing, I thought it'd be really fun to just talk through what you're seeing, objective, subjective, a little bit of opinion.
So, the first big one was valuations. What were you seeing just broadly in terms of valuations on the Carta platform?
Peter Walker:
So across Carta, obviously, there's different trends depending on what stage of company you're looking at, but valuations are ticking back up after hitting a recent low in the middle of 2023
Ā Basically across the board, there's something a little weird happening with series C that seems to still be trending along at the bottom, but C, series A, those are trending upwards in valuation, and then late stage, which has been the worst hit part of the venture market also up pretty sizably on low volume of rounds, but the valuation seemed to be trending back up. We're not close on the late stage to 2021 boom times, but at least we're not continuing to head downward.
Turner Novak:
We probably shouldn't be back to the boom times.
Peter Walker:
No, I mean, it's not like a worthy goal to say we need to eclipse 2021.
Turner Novak:
I didn't even notice that Series C had not picked back up when I looked at it the other day.
Peter Walker:
It may just be noise. It's one quarter. It's probably a few hundred rounds. There can be statistical noise in there, but it does seem as though the jump getting from say Seed, Series A is its own little world. Series B, Series C, you're really talking about companies that probably raised their Series A in '21 or maybe even '20, and so that transition is very difficult right now.
Turner Novak:
I think this is an overly descriptive - it's not always true in every case - but generally when you're raising an A, the business model isn't 100% proven out just on average. When you're raising a Series C or Series D, you're usually profitable. There are business lines. You're probably investing a lot in new products and features, but the core business probably makes money.
So to your point of if you raise an A or a B in '21, that was stretched a little bit even more all those cases. So, if you're going for your C, it's like probably going to make some adjustments downward, I would assume.
Peter Walker:
It's one of those things where if you're coming into company maturity in the boom times, and you think that, "Hey, we have a model that gets us to close to profitability, or we're making a lot of money on," and then interest rates change. Everything changes. It is harder if you've already committed to that economic model to switch it if you find out, "Hey, there's actually not as many customers willing to pay for this as we assumed." So, the middle part of the market is really challenging.
Turner Novak:
It's probably even more challenged from some of the changes we're seeing in the landscape of just AI layoffs, that kind of stuff, changing profitability, also changing velocity of product adoption and size of ACVs, contracts that people are signing. I mean, there's a lot that's been thrown out with the window, and changed in the last two years.
Peter Walker:
Absolutely. It's a totally new environment basically that these companies have to grow up in.
Turner Novak:
Probably the most interesting data point in the data to me was that seed stage evaluations have... They did not go down basically from '21. I think, we'll throw the chart up, but I believe over the last two years, maybe it's 24, 18 months, but seed stage valuations are up like 40% or 20%, 40%.
Peter Walker:
From where they were in Q1 '21, which everyone would point to as a very good quarter. Turner, it's the part of the market that I think is the most interesting right now, and there's a couple different dynamics happening. One is funds and especially bigger funds moving down market, which if your minimum check size is increased from whatever the standard historical has been for seed, it puts a floor under valuations. You really can't invest into companies at a very tiny valuation, and we're talking about priced seed rounds here for the moment. Then the other dynamic is SAFEs, companies raising multiple SAFE rounds before they get to priced equity, which used to be very uncommon, and it is now.
People do it all the time. That in itself, because a lot of those SAFEs are post money, so they guarantee a percentage ownership, it again pushes up the valuations when they get to their first price round. So, I don't see a dynamic where priced seed can go that much lower. There's a lot of floors underneath those valuations regardless of you're even talking about the intrinsic value of these companies.
Turner Novak:
I think the other thing I see too is, I mean, all these markets are just supply demand. The price just settles at the supply of capital or demand of capital and supplier demand of founders, and you meet wherever the market wants to clear at.
I think one thing that's happening is if you're thinking about pricing around and money being transacted, I think when it comes to hiding earlier, I think a lot of funds are actually hiding in more consensus founders also. So, instead of me who's probably not a consensus founder going on and raising money and probably at a lower valuation, it's somebody who worked at Google doing AI research, and now they're starting an AI company, and it's fairly consensus. They're going to get a higher valuation, so the money just doesn't clear at the low end of the market bringing the average higher.
Peter Walker:
I think that's definitely happening. People are rotating towards repeat founders even more than they ever have been, which explains a little bit. We have some other data released late last year about the demographics of founders, and there was this steady more equitable split between underrepresented minority founders and women founders, et cetera. Those percentages were climbing slowly but climbing, and then they all as a group turned down last year. The percentage of women founders fell. The percentage of funding that go into black founders fell, et cetera.
I think part of what's happening is that the rotation towards repeat founders, if you're a repeat founder by default, you were starting your company five, six years ago, and you were probably less diverse as a cohort than the people that are founding companies now. So, it's a bit of a shame, but that is one of the dynamics that happens when this downturn flows through.
Turner Novak:
I think another thing I'm seeing is, I mean, it's basically just people taking less risk, and the market perceives that as being riskier. Whether that's true or not, that's what the market thinks. I've seen the same thing with certain categories and then also certain markets like geographies.
I made a couple of investments internationally in markets like Nigeria, India, Pakistan, Vietnam. If you're a VC, and you got in trouble investing in crypto, your valuations were too high, and you're trying to course correct, right? You're like, "All right, I'm investing in the most consensus founder that matches the stereotype, and I'm also investing in SaaS or AI," versus Vietnam. Has there ever been a series B raised in Vietnam? I don't know.
Of course there has, but you're less likely to do it. You're going to do the things that are just more down the fairway, because we don't want to take risks right now. That's generally the consensus because risk capital is very, very scarce.
Peter Walker:
Yeah, totally agree.
Turner Novak:
Have you seen anything interesting in terms of sector dispersion like AI versus non AI?
Peter Walker:
Yeah. I mean, AI, certainly the story of last year, a lot of... If you're looking for where did the growth go in venture as everything was coming down in '23, AI was the category that grew, but we also saw, I thought, not gigantic but meaningful shift in some ways away from standard core software businesses in all cases and towards more hard tech businesses, so biotech, medical devices, hardware, energy, things that you're building in atoms not bits. There was those industries typically relatively on a funding basis held up a little bit better than FinTech crypto, blah, blah, blah. That, I think, is probably a good thing for the ecosystem as a whole.
It's great to be investing in places where the risk is technical instead of just execution. I don't know if that's going to hold for that long, but it seems as though that leveled out in some markets, which was... I thought that was pretty cool to see outside of the AI bubble, which is totally real.
Turner Novak:
You're saying the bubble is real or the tech is real?
Peter Walker:
I think the tech is real, but also if you look at valuations, the bubble is definitely real. I mean, series A on the platform, I think, median for 23, for non-AI was something like 39 million, whereas median for AI was 50 million on a pre-money basis. So, the gap is real. AI founders are raising more money at higher valuations. That's definitely happening. Whether or not they will become better businesses, we got to check back in five years.
Turner Novak:
That's actually lower than I would've expected. That's only like a 30% difference, something like that.
Peter Walker:
Yeah. I mean, you read about the gigantic ones, but there's a lot of that is not... Of course, people have had this debate of, "Do you invest in wrappers or only core LLM models or whatever? What stage of AI are you focused on?" A lot of the AI investment that we're seeing is not into companies building their own models. It's into companies utilizing those models to achieve whatever they're trying to do faster.
Turner Novak:
I guess you're also not capturing the revenue multiple. You're just the headline valuation number.
Peter Walker:
Correct. We don't know whether or not those AI companies are getting a much higher multiple than the non-AI ones. I would assume there's definitely some gap there, but I mean, maybe you would know better than I would when you go into AI deals.
Turner Novak:
Yeah. I mean, I don't invest in very many, but it's, I mean, double, I would say, just at least probably more.
Peter Walker:
What's your thesis on not investing in AI or maybe not investing but doing it slowly?
Turner Novak:
I mean, I think the only thing you can really control is a private market investor is your entry point. It's so hard to control the exit, so if you invest at a high multiple, you need to probably sell at a higher multiple. It's just really hard when you... You've said earlier, objectively, you were in an AI bubble. It's usually not good just broadly speaking to invest at the top of a bubble. So, it's really the only thing I can control is an investor. I mean, I can influence what I invest in. I can control that and make my own decisions, and I cannot influence really how big the outcome is, when it is.
The only thing I really have control of is how low my entry price is when I can come in. Just generally speaking, if you want to have lower entry prices, you probably need to avoid whatever the current thing is, whatever the bubble is, as hard as that is to do.
Peter Walker:
So, you're heavy in crypto is what you're saying.
Turner Novak:
I wish. I just I didn't do it fast enough. I feel like we are just getting into these bubbles faster and faster. They just inflate faster than ever.
Peter Walker:
I totally agree. I think there is something meaningful to the speed of the trend changes. AI, we've done this, what, since... ChatGPT came out in November '22, so it's been a year plus, and people are already looking for the next thing or calling it a bubble. I do think that you're moving through these cycles faster and faster.
Turner Novak:
I felt like we were already in the bubble in February of '23. I mean, I remember, I don't really use this term ChatGPT wrapper a lot, because I think really when you think about it, Riverside that we're using is an AWS wrapper. You're probably listening to us on Spotify or YouTube or Apple Podcasts, and they use the cloud. They use AWS.
Peter Walker:
RSS wrappers.
Turner Novak:
But there were some of these basically just a clone of ChatGPT, exactly the same thing that, in my opinion, we're getting a little bit too much funding thrown at them. So, it's pretty fascinating in my opinion, just the speed that it all came at. I think it's just better. Get in before a bubble. Invest in the next bubble before it's a bubble. That's-
Peter Walker:
Right. It sounds easy. Why don't we just do that?
Turner Novak:
I mean, you're the data guy. Tell me what's the next... Are you seeing any new bubbles emerging?
Peter Walker:
New bubbles, I mean, if you talk to the folks at the Gundo, the bubble is hardware. The bubble is building real tech. I don't know if I'm seeing anything on the level of AI. I do think that there's going to be... I thought this one of if not the strongest performers outside of AI was biotech for across the last two years, biotech both in terms of the actual investment and in terms of the ecosystems that are anchored in biotech specifically like Boston and San Diego just held up relatively better. Maybe it's because the cycles in venture capital work a little different in biotech than they do in other places, but that's been a bright spot. So if you're looking for a real prediction, biotech, I think, is a great place to be.
Turner Novak:
In the sense of we're going into a biotech bubble or like...
Peter Walker:
Oh, I mean, I hope it doesn't get to bubble status. Look, we just spoke about maybe the trends moving more quickly. Will anything knock off AI as the top story from this year? I don't see it yet, but maybe crypto is back. Maybe there's something else that's just around the corner, and we need to be all bitcoin maxis again.
Turner Novak:
I mean, I think Bitcoin is at all time high, and it feels like it has not had the same collective consciousness as it did the last time so-
Peter Walker:
Which is probably a good thing overall for Bitcoin, right?
Turner Novak:
Yeah. I mean, my prescription, if we're just thinking about supply demand, there could be more demand for this bubble to keep going up if we want to prescribe it in that sense. I think I remember one of the things I wanted to hit on was it looks like Boston passed New York. New York City is number two overall. I think it was dollars raised ecosystem that showed up in the data in 2023.
Peter Walker:
It did, again, probably because of that anchor. So, Boston had more dollars invested into Boston companies headquartered in Boston than New York companies headquartered in New York last year on Carta, but many more rounds happening in New York. So, just on average, the Boston rounds were bigger mostly because a lot of those early stage biotech rounds are bigger than the early stage SaaS ones. That's one of the reasons, but Boston, I don't think Boston gets the love that it deserves as a really, really mature venture ecosystem. It's the only thing that has a chance of really challenging New York and San Francisco for the long term, at least in my view. I don't think LA...
LA is just a big place, so the total numbers are pretty big, but it doesn't have the same gravity that a place like Boston does. I think Boston, the cool part about Boston is it used to be just a biotech story, and now they've got a lot of founders doing SaaS, AI, health tech. There's a lot of adjacent things that are coming out of Boston, so relatively a really good year for Boston in our data.
Turner Novak:
If you just think, VCs love funding things that match certain patterns. We've got Harvard and MIT right there. It's one of their favorite patterns to match for. Then it looks like just in the sense of deal count, so I'm just reading this, startups closed 462 seed investments or seed rounds in Q4, which was the lowest amount since Q1 of 2018, which is down 27% year over year. That supports my thesis of there's just fewer rounds clearing and happening. So, that could be why we're seeing valuations stick up, just there's less seed rounds closing.
Peter Walker:
Agreed. The only caveat there is that count 462 is of priced seed rounds. So when you throw in SAFE's, which are just a much bigger deal than they were in 2018, like big, big SAFE rounds, you get a little bit closer. The dynamics with SAFEs, I think, are really... They're pretty fascinating. It's become the default way to fund early stage companies, but it's just eating more and more into where price rounds used to be. So, it makes some of this a little bit more obscure if you don't have access to the underlying SAFE data.
Turner Novak:
You guys do not. It's only the priced equity rounds.
Peter Walker:
No, we do. I think actually, we may be the only source of data in the states that has really good information on SAFEs and comfortable notes, because they run through the platform. If Carta companies are raising on SAFEs, it's like a six click process to send out a SAFE. So, that's something I've been digging into a lot more, and it's just people are using them all the time. Even people that have already raised priced rounds, we see more SAFEs popping up in between seed and series A or series A and series B, which seems odd to me. It seems like a weird use of that instrument, but I guess people are trying to get capital in any way they can.
Turner Novak:
I mean, it's just a quick way to do an extension like, "I need to raise a million bucks. We're just going to do the same terms," or maybe we just say, "Hey, we did the last round at 20 million, and we made all this progress, and we're doing this one at 25." You're probably getting a... Maybe you're getting a deal, but maybe the multiple of whatever you're investing in on goes down. 20 is not fair anymore, but 25 is fair, and you just want to send us the 500 grand right now, and we'll just do a SAFE. We don't have to go through this whole legal thing. Maybe it's follow on for someone. Maybe it's somebody who couldn't get in to the last round, or didn't have their fund raised or something, and the SAFE is just...
For people who don't know what a SAFE is, it is a simple agreement for future equity, which basically says everyone agrees when you do the whole legal work for an official round. They'll get their shares. It's an agreement that everyone sticks to to say that you'll get your shares when you go through the process, because it's a long process. It's expensive, and it's safe. You can do it for free. There's literally templates online if you Google SAFE template as a founder, or go to Carta.
Peter Walker:
You're totally right. The value, it's the easiest, and convertible notes too in between price rounds are pretty common is, "Hey, we want to do some sort of extension or bridge. We'll do it on a convertible or a SAFE instead of a price round." The only difficulty that I see with that is that those are going to come due sometime. So if you're doing a lot of those in between price rounds, that some point the signal is like, "Why can't you just raise your B or whatever it is?" That gets tricky.
Turner Novak:
So, you have this hot take of you think there's going to be a little bit of a, I don't know, backlash is the right word, but some kind of reckoning on all these SAFEs. What do you mean by that?
Peter Walker:
So, in two forms, at the early stages, we are hearing from some VCs, not all of them, but enough that it's become a little bit of a trend that they're worried that founders don't understand SAFEs well enough, and they're giving up too much of their companies.
So, you raise a SAFE round at a specific valuation cap. Maybe you get a 500K in the door, and then you raise another one for a million dollars that's at a slightly higher valuation cap, and then you might even raise another one for a slightly higher valuation cap. All of these, if they're post-money, they guarantee a percentage ownership of the company once you raise that price round, and then they come to the price round, and they're like, "Wow, I own less of this company than I thought." The complexity of these SAFEs is pretty overwhelming at sometimes.
So, that's one. Then I guess the more interesting take from my perspective is, "Okay, there's a story out there in venture that says there's going to be a lot of companies powered by AI that will come out and raise a little bit of capital, 1 to 5 million bucks, and they just never raise again." They'll get to profitability, and then that's it.
If they do it on SAFEs, there's no automatic conversion for those SAFEs into equity. I mean, probably there will be because it's a conversation with your investors, but in the standard docs, there's no reason why that ever has to become real equity. So, I think using SAFEs to just do the tiny funding and then never take funding again is actually a bit of a different use of them, and I'm not sure it works completely.
Turner Novak:
That's a good point. I don't know the nuance of this, but I've gotten money back when companies have been acquired, and I've had a SAFE. I know I've gotten paid for that, but yeah, I'm super curious actually the technical-
Peter Walker:
I guess the question for me is are you seeing a lot of founders coming to you these days that say, "We want to take a million to 3 million bucks, and then our goal is to never raise funding again?"
Turner Novak:
I've seen elements of that. I've also seen one really interesting one. They wanted to pay dividends. It was, "We think this is going to be super profitable, and we're just going to pay you 10% of your investment in dividends every year, also, in addition to continuing to increase the valuation." But I mean, there's two issues with that.
I think one is generally, if you are a startup, your ROI or rate of return from building products is probably higher than the 10% return that I'm getting from a dividend. So, I almost feel like it's a waste of capital to be giving me my 10% returns when you could be building a company that generates 20, 30, 40, 100% returns.
That's one element of it, but then I think another element is if you just keep giving me these dividends, like there's tax implications for my investors, and then also, I have to do stuff with the capital that I get back. Most venture firms, they get that stuff, but it's not a core part of the strategy of getting these dividends back. It's just most aren't set up for that.
So, it will just take a little bit of more education and understanding from all parts of the market for that to be a thing, but that was a really interesting one that... These guys, it was a really good idea, really strong founders. They actually listen to the podcast, so maybe he'll shoot me an email after he listens to this. But, it was a super, super interesting concept of we are intentionally planning on paying out dividends for foreseeable future. It's going to probably be part of the strategy.
Peter Walker:
I think there's going to be a lot of on the edges at least, maybe not in the majority of cases, but people experimenting with what does fundraising look like? What does payout look like? There's no reason why the docs that we have today and the standard way we do it has to continue to be the way that it's done. 500 Global has this KISS standard document that's like a twist on a SAFE.
So, there's a lot of people trying different things, but just as fundamentally, people take... I think capital usually flows through the most convenient routes. So just because the SAFE is the easiest and the cheapest, it will continue to garner a lot of the initial fundraising until something else comes along and replaces it.
Turner Novak:
That's fair. Speaking of SAFEs and extensions and bridge rounds, I saw in the data, there's a chart, I believe for each quarter in 2023, this isn't just Q4, this is all year - basically, down rounds were about 19% or 20% of all funding rounds each quarter, and that was... I have to pull it up again, but it looks like it was about roughly double-ish historical averages, maybe just below double. What are you seeing there on all these down rounds?
Peter Walker:
So down rounds, you got it exactly right. It's about 2x what it usually is, which is about 10% of rounds higher the later stages, but even at the early stages, down round's still becoming more common. Guess two ways to think about that. One is down rounds suck. It's pretty obvious, but two is that at least in the down round, there's an agreement between the founders and investors that, "Hey, we got overvalued in the boom time. That's okay. We can take our valuation down. This business is still a really good viable business. It just isn't worth that right now." I think that's a silver lining. It speaks well to those people that are taking the down rounds, and moving forward.
You get into some really tricky territory if you're trying to avoid the down round at all costs, and you take on terms that are really, really investor favorable, or there's cram down like recaps. There's a whole lot of messy stuff that can happen. So, a clean down round is actually maybe preferable in some cases to messy, messy flat rounds.
Turner Novak:
I think there's almost this avoidance of down rounds. People don't want to do them, but if you just look at generally the stock market that shows daily valuations of thousands of companies, no stock just goes up into perpetuity.
Peter Walker:
Right, unless you're Jensen, but even then, it's a couple of years in the world of this.
Turner Novak:
I mean, he's done some public market down rounds if you look at the stock chart in Nvidia, and then even Facebook did a big down round when they were a massive company. When it was 10 billion valuation, they did a down round at that price, and it is one of the most well positioned companies in the world right now, one of the best cash flowing businesses ever.
Peter Walker:
It's a weird just fact of life that down rounds just hold way more stigma in private than they do in public. Now, some of that is because information in the public market is so much more opaque in the first place, and it's just like a lot of this is signal. So it's like, "Oh, you took a down round." That might scare off investors for the future or whatever it is. You also have to do a lot of explaining to your investors and then also to your employees about, "What does this mean? How does this impact their valuations?" So, it's definitely not easy, but if there was a way for the down round to be less stigmatized in venture, I think it would be very healthy.
Turner Novak:
I think too part of it is a lot of it is attracting talent, and getting smart people, and your compensation is you're going to get a lot in stock. So, it can be tricky when you're like, "Hey, our last two rounds were both down rounds." It doesn't trend well.
I mean, the human brain sees the Nvidia stock price, and says, "I got to get in on this. It looks great." So in the opposite, I don't know what's a stock that's down right now. Expensify or something, their stock's down quite a bit. I think if you're just looking solely at the stock price, and you're making an employment decision and you get compensated quite a bit, if you get granted your stock, and it's worth $100,000, and the stock goes up 5x, you actually got 500 grand, instead of 100.
You got a really good deal on your compensation. The way that you earn money, save for your family, save up to start a new company, it's a pretty big deal.
Peter Walker:
Yeah, huge deal.
Turner Novak:
Another thing too on bridge rounds, I saw that 45% of series As were actually bridge rounds or extension series As. That's a pretty big number, and that's, I think, the highest in your dataset ever historically of any round.
Peter Walker:
It's wild. It just points to the dynamic that we've been hearing from investors all year, which is I am spending a lot of time with my current portfolio companies. Most of them are asking me for more cash, and I'm having to choose amongst all of these company children that I have five, 20 investments, and all 20 are asking for more cash. I can only double down on three, maybe four.
So, the question is which I don't think our data can answer, but maybe you have more perspective on this, "Are they doubling down on the best companies? Are they saying, "Look, we want to do a preemptive bridge, because we really like it, and we want to shore up our ownership percentage or whatever it is, or are they doubling down on the companies that are we think a little bit more cash can keep them alive for a little long? We don't have a ton of hope, but maybe it's a good use of cash right now." I can't really suss out which is which.
Turner Novak:
I think it's both. I think the keep it alive, it's probably more of... itās not 100% working, but there are signs. Like, they did sign a pretty big contract, and we think they can continue to sign larger contracts where this starts to get interesting again.
Or they're on the finish line, and they have three months of runway. We just know if we give them five, six more months, they'll close a couple more of these big contracts, and they'll be able to raise the next round kind of a thing. I've seen that a couple of times. I think there's definitely an element of doubling, tripling down, just giving more money to winners.
I mean, that's a classic VC thing. It's like, "You're the founder. I'm your board member, and we're talking." I'm just like, "Man, Peter's crushing it. I just got to give him more money, because someone else is going to find out about this. I got to put more money in this thing." That's the way a lot of VCs think about it.
I've seen it with some of my portfolio companies where they will take a small early round from someone. They don't classify it as a series A or a series B, but it's like a seed extension or a series A extension that has a new outside investor, and we don't label it a new round because that investor sees how things are inflecting. In three months, it's going to look really good, but they'll probably pay a higher price. So, they just come in today, and it's $6 million seed extension instead of a series A or a $12 million series A in four months or whatever.
I see that trade-off happening a little bit too.
Peter Walker:
To your point, it's not as though bridges are always bad, right? Bridges are extensions. They can be good. They could be signs that, as you said, the next primary round investor is super excited and wants to get in a little bit early so that 45% isn't all negative. But historically, when you look at early stage rounds, it's something like 25% are bridges, 25 to 30. So, the jump is indicative of a lot of companies that are saying, "We need more cash. We need more cash, and we are going to the same people." Mostly, the vast, vast majority of these bridge rounds are being done with participation from insiders on the cap.
We're talking about one of the things we maybe wanted to touch on was dry powder and where is it going? I think some of it is being funneled into those kinds of things.
Turner Novak:
So, do you actually think there's as much dry powder as the headline numbers might say, because I feel like that's kind of a meme, right? It's like, "Oh, VCs have raised whatever, a trillion dollars. It's ready to be deployed into startups." Is that true?
Peter Walker:
I mean, yeah. Andreessen's raising a $7 billion fund as we speak. My take is no, it's not real. Let's maybe back up. It's not real for these individual founders.
So, I don't think that a founder can sit and go, "Look, there's going to be a deluge of capital that's coming in six months. I'm going to time my round to that." That's not a good way to think about it.
Where is the dry powder going? Well, one, it hasn't been called by the VCs, right? It's committed capital, but it's not called capital. So, it's not sitting in VC bank accounts. It's still with the LPs in many cases. Those LPs, especially over the last year, and especially if they worked institutions, I mean, you tell me, Turner. They seemed pretty fine with a slow deployment pace.
Not having a capital call of a million bucks if I'm a high net worth individual in 2023, that's a good thing, not a bad thing. So, that's one. It can always be slower, and there can always be agreements between the VC and the LP about the pace of deployment.
Then third, it's going into propping up current portfolio companies. It's going into SAFEs and convertible notes that nobody can really see and bridges. It's going into different places.
So, I think in the end, is there a lot of dry powder? Sure, but it's not some utopia that you can just wait for, and it's just going to show up and venture.
Turner Novak:
I think a way to crystallize what this dry powder means is if I'm an investor, just say I raised a billion dollar fund. I don't get all the money right away. It's basically, Peter, if you're giving me a billion dollars, we make an agreement of like, "Hey, you're on the hook for it when I want it," but we have this mutual understanding of I'm not going to just invest it all right away. I'll probably ā historically - we would invest it over three years.
But it got faster over the last decade where, I mean, everyone was making money. Prices were going up, so it was stupid of me to invest over three years instead of two and a half or two or one and a half or one. I mean, I think the fastest I saw was - this is just based on some headline numbers in the press - there were a couple of funds that deployed their entire fund in four or five months. Crazy.
And prices were going up, right? If I've got money to work, I should rationally should be deploying.
The way that a lot of VCs make money is actually there's this whole thing like two and 20, 2% management fees. You collect 2% of the fund size every year, and then you get 20% of the profits. You reach a certain point where the 2% management fee ā which is little bit of a tricky play on numbers, because it's 2% a year for 10 years, so it's 20%. So if you raise a billion dollars, you get $200 million in fees. That's a lot.
So, why don't you just go raise the next fund? All your valuations are going up, and you're making money, and you look good. Deploy as fast as you can to raise the next 200 million in fees, and then invest the next one faster, and you can raise the next one.
Peter Walker:
Completely. VCs at different parts of the ecosystem are playing different games. You're playing an AUM game where you're running on management fees, and you're loving it. That's basically where the big, big, big funds are now.
Or you're an emerging manager and you're playing the 20% is the thing that you really care about. You need DPI. You need to show that you are a quality investor, and you've picked quality companies. Then you've got to make sure you get it right, because the other sad thing is it's been difficult for founders to fundraise. It's been equally difficult for GPs to fundraise from LPs last year, and so inevitably over the next two or three years, there are going to be people who raise their first fund in 21 or 22 that just don't get to fund two, or fund two that don't get to fund three.
We've already seen it with OpenView returning capital. There's a lot of things going on, where the suggestion is that there will be meaningfully fewer VC funds in two years than there are right now. I think that's definitely going to happen.
Turner Novak:
Yeah, it's wild. I did my first close in my second fund in Q2 of 2022. That was a tough fundraise.
Peter Walker:
A very different experience than the first fund.
Turner Novak:
Yeah. I mean, the first one was too easy. The second fund was the right amount of hard. I mean, it was probably harder than it could have been, but I mean, it should not be easy to raise money.
I think that when we reflect on all this data, numbers are down, but they were artificially inflated, because there was appetite for risky assets. And what is the riskiest possible investment you can think of? Tech startups that are just getting started. There's this vision of we're going to change the world. We're going to be worth a trillion dollars, but we're just starting the company now. I mean, that is pretty much as far as you can get on the risk spectrum.
Peter Walker:
If you're getting 5% or 6% on savings accounts, it's a totally different world.
Turner Novak:
Well, so then when you talk about emerging manager landscape, you said it's going to be a lot trickier. What are you seeing in the data just in some of the numbers?
Peter Walker:
Fundraising, it's much slower in 2023 for emerging managers, fewer funds being started as fund formations.
Then there's a... It's a tricky moment. I feel as though VCs oftentimes are at the mercy of opaqueness and data. How are you going to go and prove to these LPs that you are the emerging manager they want to bet on? I mean, number one, if you have it, DPI is the best thing to show them like, "Look, I've returned capital to investors." A lot of funds started in the last three years obviously don't have that. So, they're trying to figure out, "How do I prove? What are the metrics, whether it's TVPI, Net IRR? What is it that I can show these LPs?"
A lot of times, it boils down to deployment pace like, "Did you sit out some of the craziness, or do you have an unfair advantage when it comes to sourcing founders?" Those things are much more difficult to prove. So, emerging managers are... Andreessen's going to be fine. They're going to fundraise from the LPs that they already have, and it's going to be okay. They're not really going to need to worry about it too much. That sourcing LPs has gotten much harder over the last year and a half for emerging managers who invest in different kinds of people. So, we would love for the emerging manager landscape to be really healthy, because I think it broadens the amount of founders and the types of founders that actually get funding, but it's been hard.
Turner Novak:
Yeah, I think one way I crystallize for people to understand what an emerging manager might go through.
So if you're, we'll just say, one of the really big funds. We'll say a16z, because they're probably the largest in terms of employees that work there. All the different functions of the business, investor relations, so raising capital, there's a team. A lot of people that do that, that work on that full time.
Portfolio support, a lot of people that just spend their time helping portfolio companies with each task. There's a team that does recruiting. A team that does go-to market. A team that does insert any kind of value ad.
You have the deal teams, the people whose job is sourcing, hunting. There's people whose jobs are winning, people whose jobs are sitting on the boards. There's people whose jobs are marketing. So, each of these scaled platforms has teams that do all these things.
When you're an emerging manager, you have to do all of those things that are normally done by a team, by yourself. So, not just fundraising, just how do you add value to your portfolio companies when you're competing against somebody that has 20 people that they're working with? It's tough.
Peter Walker:
Yeah, and there's been a retreat, I think. I don't love the word tourist. People use the word tourist too often, I think, in venture.
Turner Novak:
It's like a derogatory, humiliating type of...
Peter Walker:
It's like, "Don't gatekeep that way." It's cool to have people interested in the thing you're doing. You don't have to be this pitchfork person who says like, "I found this band first.ā
But there is a dynamic though where you say, "Okay, tourist founders, people who are excited about being founders in '21, maybe less excited about being founders in '23āā¦ it may be the same thing for emerging managers. Certainly at the biggest end, the tigers, the SoftBankās, the big, big crossover funds are all just way less interested in venture than they were two years ago. So, does that mean that there's enough great founders for the VCs that remain? Maybe.
But as you said, if you're a solo GP, and you're taking on every single aspect of running a venture fund, when fundraising gets harder, it just makes everything else more difficult too. Maybe then you slow down your deployment pace, because you're like, "I only get this one shot, and I have to pick the right company, so I want to make sure that these are perfect ones." So, that might also contribute to slower investment.
Turner Novak:
And then the consensus founders too like, "Am I going to pick Peter Walker, or am I going to pick..." We'll say you're like blue chip, or am I going to pick some other guy that I'm meeting for the first time, versus I've known Peter for a decade, and know he's contributed all these things, and he's exited a company before versus the person I just met?"
So, that definitely goes into it too. And it's not just the emerging managers. It's everyone. Everyone's going slower on fundraising.
You mentioned something super interesting, the tiger and the soft banks of the world. Those are probably the stereotypical raised large amounts of capital, and influenced the market.
Have you looked much at deal count by firm or capital deployed by firm? Does that show up in your data?
Peter Walker:
We haven't really done a great analysis of that. We would have that information for the funds that are on the fund admin side of the platform, but we would need to do some work to aggregate it from the cap tables.
It's true that, I know for a fact, there's just less involvement from big, big crossover funds than there were. But I think the shift that we talked about earlier is influencing things. Set aside the late part of the market, which is its own beast, but the early part of the market, if you have billion-dollar seed funds, the checks have to be a certain size, or you have like $500 million seed funds. You cannot invest $50,000 in these startups.
It doesn't work for your fund economics to make sense. So, that's where I think some of the influence of bigger funds is being seen is that as people move earlier and earlier, the check sizes get bigger, and the valuations cannot go below a certain floor.
Turner Novak:
I think a way to crystallize that, if you're hearing this for the first time, is if you have a billion dollar portfolio that you have to invest over, we'll just say, three years, that's historical industry standards. If a founder comes to you and says, "I'm looking for a million dollars," that is 0.1% of the portfolio.
Over a three-year period, you would have to make a million dollar investment every day to invest that billion dollar pool of capital. There's a ton of nuance, and if you have a billion dollar fund, you're probably reserving it over half for follow on. So then again, it's every two days, whatever, but then you have to actually do the things related to post investment on making that million dollar investment.
So, it's really, really challenging to justify that versus we're just going to write a $20 million check. We'll just find the guy who sold his company to Salesforce is doing some new AI thing, and we'll give him $20 million bucks. I'm buddies with them. We went to school together.
Peter Walker:
Right. We golfed together on the weekends, so of course it's all good.
Turner Novak:
So, that definitely has influenced, I think, how some of these show up in the data.
Peter Walker:
I'm interested to see... That actually was the selling point by some of these firms. In '21, they were like, "We're dumb capital. We're not going to talk to you. You're not going to need to talk to us. Here's a lot of money, and go win." I don't know. Does that value pitch that work for founders? Maybe it was only really available to the late stage ones, but to me, it seems like probably not quite as useful these days.
Turner Novak:
I think it's a compelling pitch, but you don't have to be a dumb capital fund to make that pitch. You can be the, "We're a value add fund," but you can also say, "Oh, you don't want us to help you. Great. We'll do our value add somewhere else." So, I just don't know how defensible that we're dumb capital pitches.
Peter Walker:
Anyone with capital can make the dumb capital pitch. Yes.
Turner Novak:
I think the case would have to be we will always overpay on valuation, and we'll be right about it, which is a pretty risky pitch. I don't know. It works when market's going up, but...
Peter Walker:
Yeah, it works when you're right.
Turner Novak:
Yeah. Well, okay, so when you're right, making money, the exit environment, what have you seen just in terms of on all of your data exits are happening? How are those in 2023 and Q4?
Peter Walker:
I mean, obviously, IPOs are few and far between. We had, what, five tech IPOs, and the ones that did Klaviyo and others didn't perform amazingly well last year. So, the lack of IPOs is probably the biggest single factor impacting late stage valuations. There's no IPO. There's no way to price discover what the public markets really think about these companies. It gums up the works of a late stage venture.
So, we need the IPO market back. Really, really hopeful that later this year, not betting on the first half of '24, but I would put a little bit of money on the idea that one or two major companies will IPO in the latter half of this year. It depends on interest rates. It depends on a lot of things, but hopefully that's the case. Public stocks are doing quite well right now, at least the big ones.
The other way that exits happen though is M&A oftentimes. There was an idea that M&A was going to boom last year, because valuations are falling. There's a lot of these companies could be attractive if their valuations got more in line.
M&A was basically flat on Carta. It's about 150. Companies are acquired off of the platform every quarter. That's slightly down from '22, but basically flat quarter or year over year. So, maybe this year will be a year of a lot of M&A. I think maybe, again, that's a little bit optimistic. Perhaps the reason that not a lot of M&A is happening is because people got under the hood of these companies.
They're like, "Well, this isn't... M&A is a difficult bet at the best of times. Maybe this isn't where we want to be playing," but I'd expect some more acquisitions than last year. But exits, you can't... As the saying goes, in venture, you can't eat TVPI. You cannot eat these metrics until they become real, when you actually get an exit and actually return cash to people. Those have been far between.
Turner Novak:
I think the sort of thing that I'm seeing is why would you exit in '23 if it was a "down round, bad deal." You still had cash. There's definitely some cases where let's continue to try to make this thing work. I think '24, they'll probably be a pickup of, "All right, we have to sell now." That would be my guess.
Peter Walker:
We got to bite the bullet.
Turner Novak:
I don't know in terms of dollar amount, because some of these companies will be running out of cash. They're acquihires, so the dollar amount may not be that much higher, but I feel like the count, I would expect it to be higher in '24 than it was in '23 and '22. That would be my guess.
Peter Walker:
I think so too. And it's the kinds of companies that are getting acquired, obviously, the later stage you go, the more difficult an acquisition becomes, both because of regulatory reasons, but also just like there's fewer buyers that can buy really, really big late stage companies.
So, the most common one is about 30% of the companies that are acquired on Carta every year are acquired after their Series A, so between Series A and Series B. It seems to be a sweet spot of real enough business, but also not too big that it's really difficult to digest for a bigger tech company or a private equity firm or things like that. So, that seems to be the sweet spot.
Turner Novak:
I was going to say that's actually a question from John at RBC, our mutual friend. He wanted to know what is the most common time for a company to get acquired, or what was the most frequent prior financing round? Is it Series A?
Peter Walker:
Yeah, it's Series A. I mean, it's a little tricky, and that there's a number of acquisitions that happen that are in the pre-seed space. You probably would term them acquihires. Difficult to know the reasoning behind that, but if you look across acquisition timing, so in 2023, about 27% of the companies acquired were acquired after their Series A, another 20-22% after their Seed round. So, that early part of the market is fairly acquisitive.
Turner Novak:
Roughly half, just below half.
Peter Walker:
Yeah, just below half or so that are going to get acquired in that Seed - Series A range. Then if they haven't raised the priced round, there's a number of acquisitions there too. But again, those are probably mostly just the, "Hey, I think this team is really great, or I love this as a feature."
Turner Novak:
I think surprisingly, those can actually be better financial outcomes for founders or for early stage investors. I guess I'll just walk through the scenario.
Let's say your company was acquired for $50 million. You've raised a total of $10 million. Usually, there's this thing called a liquidation preference that just says... There's usually a number attached to it, so a 1x liquidation preference. Very roughly speaking, if there's an exit event, the investor or the shareholder that owns that share with the liquidation preference, they get their money back before anyone else gets money. So, they sit at the top of the distribution of capital.
So if your company's acquired for $50 million, there's $10 where they get their 1x return no matter what, and then the $40 million is split, there's different ways it flows based on share classes and all that kind of stuff, but everyone can make money in that kind of situation.
Now, let's say you were acquired for $50 million, but you raised $50 million, or you raised $100 million, and someone with a 1x liquidation preference sits at the very top. Let's say you raised $100 million, and you sold for $50 million. They don't even get their 1x return when that $50 million is distributed, so everyone below them gets zero.
So, you might say like, "We raised our Series B, and we were acquired," but less money actually went to the founders or the early investors, than the Seed round that got acquired. It's a little bit counterintuitive.
Peter Walker:
The bigger number on the headline is not always better depending on what the preferences are and the money that you've raised. A lot of times, and that's why people get really frightened by things like 2x or 3x liquidation preferences, which state that the investor doesn't get their money back. They get twice their money or three times their money before anybody else on the cap table sees a dollar. So, those provisions can be really... They can really tamp down the actual end value for founders and employees.
Turner Novak:
What did you see in the data on those types of rounds just over the last couple of years? How did those trend?
Peter Walker:
They were more common, as you can imagine in '23, but I think that their prevalence is actually a little bit overstated. It's only about 8% of deals on Carta that have a liquidation preference over 1x. So, it's still a very small minority of deals that have this.
I will say that number jumps or that percentage jumps quite a bit higher in bridge rounds, and so some of those bridges are definitely people doing anything they can, and agreeing to some fairly onerous terms in order to get money in the door and stay alive, but it happens. I think Jason Lemkin from SaaStr has some really strong opinions about how actually liquidation preferences don't really come into play that often. You're either going to go out of business, or you're going to exit for a billion dollars, and everyone still makes money.
I think there's probably a messy middle there where it does come into play, and a lot of founders earn less than they think. But I think on the liquidation preference side, the thing that's most challenging for me to look at is just how little employees understand about those kinds of things. Employees at a normal startup, they just see the fundraise amount, and they see the valuation, and they think, "Hey, this is awesome. I'm in the money. Let's do it." They don't really realize there's a lot less cash available to employees at the end bottom of that waterfall.
Turner Novak:
Yeah. So, what are you seeing just in terms of compensation markets? The things that are interesting to employees here in your data.
Peter Walker:
In the report, we showed that a few things happened last year that were really interesting for employees. So first, on the hiring environment, startups across Carta hired about 268,000 people last year, which seems like a very big number. But then you look to 2022, and they hired over 500,000 in people. So, hiring was cut basically in half from the year prior.
Layoffs, if you take layoffs and departures like people leaving by choice, and add those up, they actually totaled more than the new hires. So, startups as an industry got smaller in 2023, which is the first time that's happened in the history of Carta for sure. It just... all of the headlines or talk out there about investors and founders getting more serious about headcount, making sure they're managing payroll really closely, that's 100% true. This was the year of headcount reductions.
So, that's first. Hiring was way down. Two, employees salary compensation didn't grow very much, but it didn't fall very much either. I think it was up about half a percent or so on average. So, not keeping pace with inflation, but at least it's not falling.
Equity compensation over 2023 fell by a quarter or maybe even more. That's not just because the companies were valued less highly. So if you think of it as a pie, each individual person was receiving a smaller slice of pie, and that total pie was worth less. So, it's both sides happening to employees. Equity comp was really down.
And employees responded as you would expect them to in this sort of environment by just saying, "I'm not going to exercise my options. So when I leave this company, either through layoff or because I got a better job somewhere," you have that 90-day period typically to exercise your options, and make them real stock.
Only about 23% of employees are actually doing that, which is a bearish signal from employees about the future value of these companies.
Turner Novak:
That is cut in half. I think it was 46% in Q4 of '21, so exactly 24 months prior.
Peter Walker:
Exactly. You would expect that exercise rate to be pretty cyclical. If you're on a rocket ship, you're much more likely to exercise than if you're looking around the headlines, and you're like, "Oh, my company did a down round," but it's wrapped up. It's so deeply part of the promise of startups is that you have this upside bet. So, we want employees to at least be thinking, "Hey, it's worth taking that chance," and they're choosing not to.
Turner Novak:
I saw that repricing of options was also up 3 to 5x over two years ago, or maybe historical averages. What does that mean exactly? Iām not actually 100% sure if I know what's going on there, but also for the audience.
Peter Walker:
It's a little bit of a complex thing. It's actually a good thing. Iāll state that upfront.
So, say a repricing happens. Let's say you and I are founders of a company, Turner. We look around, and we say, "Look, we think we need to take a down round. We got overvalued in 2021." What might happen then is that the value of the equity that we gave out to employees that we hired in 2022, say, is actually below the new valuation that we're taking on for that down round.
Turner Novak:
You mean above or below?
Peter Walker:
Below. So, the 409-A valuation of the employee stock is above the new valuation for that round. So, there's no upside left in this. I'm underwater on my options. So, what can happen then is founders... This is not required, so this is actually... It's a good move by a lot of founders and boards. They can say, "Look, we still believe in this company, and we believe in these hires. We want to take their 409A valuation, and lower it to whatever the new 409A valuation is so that they have upside remaining in the business." They do that by retiring the old options usually and issuing new ones. There's a lot of board dynamics that goes into this, but effectively, repricing is founders and boards giving employees more upside in their equity.
So, it's not required, but it is pretty cool to see when people really believe like, "Hey, my employee population should remain incentivized in this company." It's more frequent than it used to be. Most of that is happening at the late stage. Not a lot of repricing in seed or series A stock, but good to see that founders are taking that very seriously too.
Turner Novak:
I think it's probably easy to see the headline layoff numbers, and think these are capitalists, don't care about people or whatever, but I mean, at least this is a sense of, "Okay, well..." They're trying to do something. They're trying to keep the company alive, and they're also trying to do as well as they can, or treat their employees as well as they can. Actually, a question from Semil Shah, prior guest to the show, he wondered if you're seeing anything in secondary activity.
Peter Walker:
So when we look across secondaries that are happening not through Carta, but we know about them, because at the end of the day, when a secondary happens, things change on the cap table so we can have an aggregated, anonymized view of that. Secondaries were... The activity level was pretty down last year, which is almost like... Usually, secondaries happen after a primary round. So, fewer primary rounds means fewer secondary trades. There's a lot of interest in secondaries. Can you snap up these brand name companies for-
Turner Novak:
At a discount.
Peter Walker:
Yeah, at a discount. But usually, at the moment, what we're seeing is that buyers and sellers are still pretty far apart. The sellers are interested, or excuse me, the buyers are interested, but the sellers are still anchored on that higher valuation, and they're not willing to give up the stock or the options quite yet. I think that'll pick up once the valuations continue to turn around.
The other type of secondary activity that happens is fund secondaries, where investors are actually selling positions in the fund. That, I don't have a lot of data on, but we've heard anecdotally that that's more active than it used to be. So, a lot of how do you trade private market positions happening? It's a completely opaque, and nobody really knows what's going on kind of market.
Turner Novak:
That can be an interesting way to get an exposure to a company. Let's just say there's breakout ABC company, hottest AI company. Everyone wants it, super hard to get access to shares, but this Banana Capital fund that sucks, but they have this one position in ABC company. You're basically just buying. If you buy a stake in the fund, you're basically getting that one position. There's a little bit of that element potentially too on the early stage funds.
Peter Walker:
Exactly. It's like how do we get into the winners? I could do that directly, or I could do that through a fund that's already invested in those winners, but that's the end goal most of the time.
Turner Novak:
Yeah, because that's usually how someone's underwriting is if they were looking at a fund like, "All right, what are the two companies in here that are actually working?" The other ones are maybe call options. They might work, but we're basically saying, "All right, they're a seed fund. They have one company. It's a Series C stage. It is pretty clearly working. That's basically what we're prescribing the entire value of our new position. We're buying it based on what we ARE going to get from that one single portfolio company.ā
Which is maybe counterintuitive because it's a portfolio, but, I mean, usually in the secondary markets, you're thinking about downside. You're getting a deal. You're controlling that entry price where you're... I think the good secondary buyers are usually they're acting with leverage. They're waiting where the market's in their favor. So at a time like now where people need liquidity, you can usually get a bigger discount, because that's what you can control. You can't control the exit, but you can control where you come in at.
Peter Walker:
Yep. To the point about liquidity, if you need DPI, if you need to show or return some cash to investors in order to start fundraising and things like maybe that's more attractive to you than holding onto this winner that you have... Where people exit is a really interesting whole other hour and a half of what's going on in venture, and how people think about exits and all that kind of stuff. It has been invest early hold until the IPO. Maybe people will try to get off that train a little bit earlier in some places.
Turner Novak:
Yeah. Is there one or maybe multiple interesting data points that you've seen? Historically, your entire time looking at all the data on the platform, what are the most surprising data points that have just stuck out to you? These can be literally anything.
Peter Walker:
I mean, there's a lot of different ways to take this. I think there are probably two interesting data points for early stage founders.
One of the things that we found is that we did this study of about seven and a half thousand companies on Carta, and we looked at how co-founders split their equity before any financing, before any employees. It's just like you and your co-founder in a room talking about who owns what in this company.
The standard advice usually offered by YC in many cases is split equally. 50/50 is the right thing to do. You're going to be building this business for a decade, and that's great advice. That's a wonderful way to do the business.
What we found when we did this study though is that most founders don't do that. About 62% of two founder companies did not split equally. So, only about 40% did. Then you can imagine as you get to founders that are three founders, four founders, five founders, it's actually quite rare to split a five founder company 20, 20, 20, 20, 20. That doesn't happen very often.
So, investigating those choices was really cool, and seeing how founder equity dynamics play out when the founders are starting this company together versus when maybe a founder comes in a year after the company has started and joins as a co-founder, I found all that early decision-making stuff really, really fascinating.
Turner Novak:
Interesting anecdote on that, I've seen two people start a company together. Six months later, one co-founder leaves. They go from 50/50 or 60/40 down to 95% and 5% or something like that. Then the new co-founder that comes in a year later gets 20%, so then it's like the exited co-founder that helped get things started, maybe the first engineer or something, they own five. Then the new co-founder, 20%, 25%, 30%, something like that. Then the other co-founder that's been there the whole time has 60%, 70%, whatever my numbers add up to, something like that. So, that's an interesting one that I've seen too in the sense of how it can split just based on timing of when they also joined.
Peter Walker:
The underlying point there is have a vesting schedule on those shares. You don't want to go through a co-founder divorce, and then come out of it and say, "Well, we split this thing 50/50, but now it's a year in, and you own your full 50%, and I own my full 50%," and there's no mechanism to get that 50% back except for talking to this person that you've obviously had some difficulty with. That's a really tough place to be. So, founders on the call put vesting schedules on everybody's equity, founders included.
Turner Novak:
I've seen it kill businesses too where they didn't do that. It's 50/50. One person leaves, and effectively, half of the cap table is dead. That second founder is no longer involved.
Typically in an ideal world, all the cap table is working trying to make things happen. And when you suddenly cut off 50% of it, it's just so hard to attract new investors, because they'll see that, and be like, "Who's this person that is not involved that owns half the business?" So, sometimes what I'll see is just in the best case scenario, the founder that leaves, if they didn't have things vested, they will give some shares back or something, or maybe they'll sell them to the business back at a discount. Maybe that's potentially what can happen.
But ultimately if you don't fix that, it can just kill the business. So you say, "I still want to own 50% of this thing that I worked on.ā Well, if that's not worth anything in the future, it doesn't matter how much you own.
So, I think it's worth going through the exercise of being like, "I'm okay giving up a lot of this in the sense of it will still be worth something in the future, because I gave up a certain percentage." You want to maximize your potential for that to actually materialize because the reality is it probably won't.
Peter Walker:
Yes, you're already working with small probabilities anyways, so you got to base a lot of decisions on that, but debt equity is a major reason why some businesses can't receive funding because VCs look at it and say, "Look, there's not enough left for both the future investors and for you the founder. You're just not incentivized highly enough to keep moving."
Turner Novak:
Yeah, and sometimes what'll happen later on in a company's life, whether it's a bridge round, or it's a pay to play down round, whatever, you can restructure the cap table. You can just say, "All the existing investors, if you don't participate in this round, the class of shares are going to change." So, there's ways to get around it that are a little bit less exciting to talk about, but there's ways that you can influence change the cap table a little bit.
So in terms of talking about dead equity, managing all these weird cap table situations - you've mentioned in the past, really interesting data point. 2023 had the most shutdowns that you've ever seen in the history of Carta platform. Can you talk about that?
Peter Walker:
It's unfortunate, but just fact of life. There are a lot of businesses just didn't make it out of 2023. About... I think, it was close to 1,000 in the end that shut down across Carta last year for bankruptcy dissolution. There's a lot of different ways to term it, but basically closing up shop as a startup.
Turner Novak:
How many total startup customers does Carta have? Or what percentage of the customer shut down?
Peter Walker:
We're at about 43,000 companies on the platform now. So as a percentage, it's not that high. It's a little difficult to do those percentage mathās though because of the different stages.
So, one of the ways that I would illustrate how difficult it was last year is if you just take startups that had already raised $10 million bucks. So, these are not idea stage startups. These are companies that have raised significant amount of capital. Shutdowns were about 2.5x more than they were in the prior year. So, even companies who'd raised significant cash and were real businesses were also shutting down. So, it was just a really difficult year for that.
I think one of the ways or one of the difficulties that founders have is that the shutdowns are happening at the same time as all of these major AI rounds are being raised. Especially this coming year, I expect fundraising to get better, but I also expect a lot of companies to shut down. So, it's going to feel very bipolar or dichotomous depending on where you sit in the venture ecosystem.
Turner Novak:
It's like the ebbs and flows, different segments of the market diving down.
So then you just mentioned something I know we were going to talk about. You think it's going to get better in 2024. What are you seeing to make you think that?
Peter Walker:
Maybe I'm just naively optimistic.
A couple things, so one, December was a good month for fundraising. I think that Q1 has started off pretty good as well in terms of startup fundraising. Again, to your point earlier, it's not super useful for us to always compare to 2021, and say, "This is where we need to get back to." It may be the case that we don't get back to that level of funding for more than a few years yet, and that's okay, but we are rising, I think rising up. Valuations seem to be rising pretty steadily, especially at the early stages. So, that's all positive.
Then the other prediction that I would have, or I guess it's less of a prediction and more of just the really open question, is, "Okay, all of these companies that are starting or started last year or starting right now, will they be able to grow faster with less headcount and higher revenues more quickly than any companies we've seen before? How does that change venture?"
I'm super fascinated by the idea that a company can take in 1 to 2 million bucks in funding, keep the team really small, and use AI to automate some things, and then explode mid-journey and other places maybe as examples of this. I think a lot of companies are going to try it, and I'm fascinated to see whether or not you can get a lot of venture scale outcomes without a lot of venture money.
That would change the whole landscape of venture capital. We may not see all of that come to fruition in '24, but we're definitely going to see a lot of companies try it.
Turner Novak:
When you think about the dry powder that's out there, a good chunk of it is not inception stage pre-seed dollars. I mean, that's 5%, 10% of the capital. Majority of the capital is later-ish stages. So when you say there's this new trend of not raising the later stages for high double digits, almost three digit, you were talking like 80%, 90% of the capital is not going to be able to be deployed into this. That's an interesting supply and demand function of where does that all end up.
Peter Walker:
My instinct is that everyone's talking about the Sam Altman thing of there's going to be a billion-dollar company run by one person. That's cool for Sam. Kudos to him. He's got the right to say that. My gut is that as things get healthier, people will do what we usually do and say, "Hey, funding's actually good. Let's turn back to the boom times." If it's the case that founders really are that laser focused on capital efficiency, and want to keep things really small and not raise a lot of money, where does that mid-growth VC capital go, I think, is a fascinating question.
Turner Novak:
Where do you think it will go if you had to give a take?
Peter Walker:
My best guess is that the deals will get so competitive that they'll just be more capital invested into fewer companies at really, really high valuations or rounds. If you're sitting on... If you have a six or $700 million fund, and you're writing $5 or $10 million checks, and no one's taking your check, because they say, "We don't need to fundraise," maybe you expand that to a $20 million check, and say, "Well, would you turn down $20 million? What could you do with this?" I don't know. I think my gut is that it won't actually... Not a lot of businesses are going to be able to do this without real significant funding, but maybe I'm wrong, and AI will change everything.
Turner Novak:
I think it just generally compresses returns. If you have valuations going up, returns compress, which then less capital flows into the space, harder to fundraise, etc.
I feel like this whole, "We're not going to raise," thing is it's like a teenage phase where you're like, "I don't want to talk to my parents." I think it's going to... I totally respect it, and I think it's a great way to run a business. I just feel like eventually, you're going to get a deal that you're just like, "Man, we can move so much faster, hire so many more really talented people, and the outcome will actually be greater, faster if I take this venture money."
I mean, the thing no one talks about is how amazing and incredible the venture capital content marketing industrial complex is of just convincing people that you need to take their money. It's an incredible flywheel, just the things that they do.
Peter Walker:
It's probably the best example of content marketing that I find across the internet these days is just how deeply embedded the idea of venture capital is for "startup founders." I think also, some of it comes from the fact that the word lifestyle business sucks.
Turner Novak:
Yes, it's so derogatory.
Peter Walker:
Yeah, just call it cool small entrepreneurship. I don't know. There's got to be a better name for that, because right now, it's so derogatory, and that's not cool. Those businesses are fantastic. They just don't have venture capital.
Turner Novak:
Your lifestyle business that's only worth $100 million, that's so gross. It's like, "Come on."
Peter Walker:
It's like a B2B SaaS tech business that's worth a hundred, $200 million, and you're just poo-pooing it on the side. It's like, "Yeah, but you didn't grow 100% last year, so we're not interested."
Turner Novak:
I mean, the incentives are to deploy capital. That is the incentive of the VC industry. It's raising money and deploying capital. It's really not generating returns. So, it skews towards trying to incentivize people to take their money really at the end of the day.
I'm trying to think of anything else interesting on the future of venture. I think the SAFE thing is an interesting proposition that you talked about is like, "Will we need a new form of early stage financing if we are not raising as much later on, like how the SAFE evolves?" That's an interesting development to watch.
Peter Walker:
Yeah, maybe we see a return slightly to a convertible note, which at least because it has the interest rate and the maturity date, it forces the conversation. There's a conversion mechanism there. I still think the SAFE is going to be default how a lot of fundraising happens.
The other maybe not prediction, but interesting idea here is there's always talk on Twitter and other places about where's the best place to start a business, or which venture ecosystem wins. To date, that has always been Silicon Valley, and I don't think there's a lot of data that point to something other than Silicon Valley winning, especially with AI being so focused on San Francisco.
But, what I am interested in is effectively, the rates for SAFEs, the valuation caps and other things are starting to normalize across the country. So, you're actually not getting as much of an arbitrage if you're a Midwest investor as you used to or a East coast investor as you used to when you compare it to west coast places, there are fewer companies, but they're raising pretty healthy amounts on SAFEs at pretty decent valuation caps. So, the national market for early startups is slowly converging.
Turner Novak:
I think, I've always run into this thing personally where if somebody says they're a geographic-based investor, and they invest in the best startups, and we'll say Texas or something, or we'll say Arizona, I don't know, nothing against these markets at all. I don't even know if this is true, but I'm sure there's funds focused there.
But let's just say you're the best startup in Arizona. Who's to say you might not raise money from a Sequoia or Founder's Fund, or insert whatever fund that's based in the coast? I mean, I think the interesting thing that happens there is the cream will always rise to the top, if that makes sense.
Then to your point about valuations rising, everybody uses comps. So, let's say we're Midwest. The average valuation is $3 million for the very first round, but you're Peter Walker, this amazing founder. You raise from a West coast investor, and you raise at $10 million, and you're based in Arizona. Then another founder in Arizona says, "Well-
Peter Walker:
Peter got $10.
Turner Novak:
Peter got $10. Maybe I could do $5 million. Then that becomes a new standard. And then someone else says $15. Then you say, "Okay, well, why can't we do $8? That just seems reasonable." Then suddenly, you go from raising at three to raising at eight as the market average, and then to your point of San Francisco is, "Okay, well, San Francisco will say is nine or $10 million." Suddenly, there's no difference really at the end of the day.
Peter Walker:
I think that dynamic is definitely happening across the U.S. There are still regional differences. I don't want to paint this as it's a completely national picture, but the other cool ecosystem thing that I'm curious about, and watching is just the density of angels in a specific place. It's like, "How many people in that place of the rich individuals that live in Dallas or Houston or Tempe, Arizona, what percentage of them invest that disposable income in startups versus a market or real estate or whatever?" That, I think, is a cool indicator of how entrenched this startup culture is in a place.
You walk around San Francisco. It feels like everyone's an angel investor, whereas you walk around Phoenix, and it probably doesn't feel that way. That, I think, is cool, and you're starting to see it increase in places like Austin and other places that have really taken off as VC markets over the past few years.
Turner Novak:
Are you able to see any recycle of capital? Do you see that in your data where it's like, "Oh, we're seeing exits in Austin, and we're also seeing more angel activity in Austin?"
Peter Walker:
We would maybe be able to correlate it. We wouldn't be able to say like, "This person did this specific thing."
Funnily enough, though, I was talking with an investor the other day, and he was saying that basically, the way that he termed it is the whole nation of Australia is waiting for Canva to go public. That would be the biggest recycle moment for the country as a whole, so yeah, people definitely are betting on the idea that more exits means angels do well, and then they go back and recycle that capital into new businesses.
Turner Novak:
So, another way to think about these emerging hubs is we'll say like Boise, Idaho, Tempe, Arizona, Detroit, Michigan. What is the expectation of some of those angel investors? Are these people who say, "We're in this for 15 years, or are we trying to get a 2x return in three years kind of a thing?" I think that influences how a hub will evolve too.
So to your point on Austin, or to your point on Australia, the type of capital that is being recycled and being put back in. I think if it's a startup founder or startup employee that gets liquidity versus a real estate investor or a lawyer or a doctor, I just feel like they generally have different return expectations, and how they approach angel or early stage investing too.
Peter Walker:
Absolutely. So, I guess the question there is will Silicon Valley educate everyone else to the boom bust model that we've defaulted to? It needs to 10x or 100x at this stage, or it's not worth it, or will the rest of the country as more people get involved in this part of investing change the model, and say, "Hey, actually, 3x, 4x is pretty good? We should figure out a way to recycle capital faster."
The venture capital industry, the way it works in San Francisco is wonderful, and it creates these immense outcomes. But it does leave a lot of companies on the wayside that probably could be pretty good businesses. They just took VC, and they had to grow at a super high rate.
So, maybe there's a better, more healthy middle where there's an off ramp from venture for some of these companies that are good companies. They're just not going to grow 300% a year.
Turner Novak:
I think you have to have large pools of capital waiting with the right return expectations, because you can't just say... Because the entire venture industry is set up on power laws, massive outcomes. You can't just say, "Hey, in your fund that's set up for that, do you want to do a couple of these single doubles instead of grand slams?" You have to have the whole portfolio set up to try to fund grand slams. So, you almost need new pools of capital raised to say, "Hey, we are offloading." We are helping you ramp off.
We're only trying to hit singles. We're trying to get a 20% return on every single investment, because you can't have half of your venture fund say, "We're trying to hit singles," and then you don't hit any grand slams, and you have half your portfolio that's literally goes to zero, and then half that's singles, and you barely return any of the capital to LPs. LPs won't invest in that. The ecosystem will die.
Peter Walker:
Fund by fund, you can't switch strategies, and then in the middle of the fund, and be like, "Oh, we're cool with 2x for everybody." Definitely not, but could you build... There are some interesting investors or interesting players in the venture market who are saying things like, "I know of one fund that all they do is they review all of the seed and Series A transactions going on, and then they just take other funds pro rata at the B." So they say like, "Oh, I think you're a cool. You're a good investor. You can exit now, and you keep focusing on the early part of the market, which you seem to be fantastic at, and then we'll take the capital from B onward, and do that baton handoff."
Maybe that's a way to structure things that gets recycled capital a little quicker, because on the recycled capital point, startups are staying private for a dozen years, 14 years. If you're trying to make it to IPO, that's a huge amount of time to have your capital tied up.
Turner Novak:
I feel like the tricky part... I mean, I mentioned this a couple of times. The tricky part is you've got to make sure you get those big outcomes, though. If you get out of the big outcome too early, it breaks the venture model. So, you definitely have to balance of making sure you're taking your liquidity at the right point that matches the venture capital asset class.
Peter Walker:
I mean, that's why they pay you the two and 20, right?
Turner Novak:
Yeah, the 20 and 20.
Well, yeah, because I think an interesting point with a couple of portfolio companies, where they're trying to get some early investors to sell secondary in a hot round. And you invest the risk capital early on. It's not clear it's going to work. It finally starts to work, and then you get out, and you take it all off the table. It just breaks the model. You got to continue to see the fruits of taking the risk early on. That's the point of venture capital.
It's super fascinating. I mean, there are so many different ways to do this and how to run a fund, how to make your decisions.
Peter Walker:
Totally. Those are the really tough decisions for GPs out there is like, "How do we make money on this, but also remain super long-term incentivized with the founders to hit the IPO market?"
Turner Novak:
Well, this has been an awesome conversation. Thanks for coming on.
Peter Walker:
Thanks for having me.
Turner Novak:
I think we'll throw a link to the Carta data insight newsletter in the show notes, but quick plug for that, what would you plug?
Peter Walker:
So, it's called the Data Minute. We release one newsletter every week on Thursday mornings, one chart about something within those 43,000 companies that's interesting or fun. If you like data or insights on startups, I think you'll find it really useful.
Turner Novak:
Awesome. I think this entire conversation was structured around data that you put out in those newsletters, so awesome.
Well, this is great. Thanks again.
Peter Walker:
Cheers. Thanks, Turner.
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