Canvas Prime's Lynn: Looking for Right Deal, Not Hype Deal

Key Concepts

• Bubble vs. Profitability: Debate on whether the current market is a bubble, with arguments for and against based on company profitability (e.g., NVIDIA, Alphabet).
• Private Market Diligence: Increased scrutiny on private companies, focusing on customer contracts and actual revenue recognition beyond ARR.
• Annual Recurring Revenue (ARR): A key metric, but often misused or misrepresented in private markets, including pilot or installation revenue.
• Customer Due Diligence: The practice of speaking directly with a company's core customers to validate their usage and commitment.
• "Peeling the Onion": A metaphor for deep due diligence, uncovering the true financial health and operational reality of a company.
• Cult of Personality/Story vs. Substance: Investors are urged to look beyond charismatic CEOs and growth narratives to fundamental business metrics.
• "Big Box Firms": Large venture capital firms with significant capital to deploy, potentially leading to less rigorous due diligence.
• Capital Deployment vs. Diligence: The tension between the need to deploy large amounts of capital and the importance of thorough due diligence and governance.
• Valuation vs. Governance: A growing concern that governance issues (e.g., founder control) are being overlooked in favor of high valuations.
• Concentration of Capital: A significant portion of venture capital is flowing into a small number of deals.
• Series A/B Rounds: The stage of investment being discussed, with examples of extremely high valuations for early-stage companies.
• Board Control: A critical governance issue where founders demand complete control, even in early funding rounds.

Investment Approach in a Hype Cycle

The discussion centers on how early-stage investors should adapt their approach during what is perceived by some as a market bubble, focusing on identifying and investing in companies with the potential for significant long-term growth ($5 trillion companies) regardless of the current hype cycle.

Bubble Debate and Investor Reaction

• Rebecca's Stance: Believes the market is in a bubble but emphasizes the importance of how early-stage investors react and execute their investment strategy.
• Counterargument (Caroline): Some argue against a bubble, pointing to the profitability of public companies like NVIDIA and Alphabet.
• Private Market Nuance: For AI and private companies, the lack of profitability is attributed to heavy investment in growth.

Due Diligence in Private Markets

• Focus on Customer Validation: Rebecca highlights the necessity of digging into companies by speaking directly with their core customers. This involves asking questions not typically asked in venture capital before, such as reviewing all customer contracts.
• Misuse of ARR: The term "Annual Recurring Revenue" (ARR) is identified as the most overused and often misused term in the English language within private markets.
• "Peeling the Onion" of ARR: Caroline questions the extrapolation of past monthly revenue to a 12-month basis. Rebecca elaborates that investors must "peel the onion" by talking to customers because contracts often include ephemeral revenue like pilot or installation fees, which can be canceled with short notice (e.g., 30-day outlays).
• True Customer Commitment: The focus is on companies whose customers use their product not as a trial or R&D experiment, but for their day-to-day operations in critical sectors like financial services or healthcare.

Lessons from Past Failures and the Cult of Personality

• FTX Example: Caroline references the FTX situation, where a company believed to be a winning formula was found to be using QuickBooks for its accounting, illustrating the danger of overlooking fundamental financial practices.
• Beyond the CEO and Story: Investors are urged to move beyond the "cult of personality" and the "story of growth" to truly understand a company's underlying value. Rebecca emphasizes staying focused on "doing the right deal, not the hype deal," even when it's difficult.

The Challenge of Large Capital Deployment

• "Big Box Firms" Dilemma: Rebecca describes large Silicon Valley firms with over a billion dollars in funds as facing a different problem: they have too much capital to deploy.
• Skipping Diligence: This excess capital can lead to skipping crucial diligence and governance checks, prioritizing capital deployment over deep dives into a company's long-term viability and return potential.
• Risk of "Running on QuickBooks": The concern is that these firms might invest in companies that are not fundamentally sound, akin to the FTX example.

Valuations and Governance Concerns in Series A/B Rounds

• Extraordinary Valuations: Caroline points to examples of massive seed funding ($6 billion for a potential Bezos project) and companies raising at $50 billion valuations from $12 billion seed rounds (referencing Mirror Bharati).
• Concentration of Capital: Rebecca notes that a large majority of venture capital is concentrated in a few deals, citing that 62% of venture money last year/this year went into just eight deals. She sees this as an opportunity.
• High Valuations for Low Revenue: Deals with sub-$10 million in actual revenue are being valued at over $500 million.
• Walking Away from Deals: Rebecca has walked away from two deals in the last 30 days with such profiles, not due to valuation, but due to governance issues.
• Founder Demands for Board Control: In both walked-away deals, founders demanded complete board control in Series A rounds, not just through voting shares but over every major company decision.
• Historical Perspective: Having invested through multiple cycles, including the dot-com bubble, Rebecca views this level of founder control as a "recipe for disaster."
• Governance as a Greater Concern: Rebecca expresses more concern about the current lack of governance than the actual valuations and money being invested.

Synthesis/Conclusion

The core takeaway is a call for a more rigorous and discerning approach to early-stage investing, particularly in a potentially frothy market. Investors are advised to move beyond superficial metrics and charismatic leadership to conduct deep due diligence, focusing on customer validation and actual revenue. The increasing trend of founders demanding absolute board control in early rounds is highlighted as a significant governance risk that could lead to long-term failure, even more so than inflated valuations. The concentration of capital in a few deals presents both a challenge and an opportunity for investors willing to prioritize substance and governance over hype.