TWIST VC Roundtable: Startup Valuations, Secondary Markets & the YC Revenue Illusion | E2137

Key Concepts:

• Secondaries (GP-led, LP-led, tender offers, strips, slices, continuation vehicles)
• DPI (Distributed to Paid-In Capital)
• TVPI (Total Value to Paid-In Capital)
• M&A (Mergers and Acquisitions)
• QSBS (Qualified Small Business Stock)
• Emerging Managers
• Revenue Quality (ARR, GMV)
• AI-enabled Services
• Hardware as a Service
• Year Zero Startups
• Handshake Protocol
• VC fund dynamics (Mega funds vs. Seed funds)

1. Secondaries Market and Liquidity

• Global secondary activity is rising, estimated to reach $122 billion this year, up from $105 billion in 2021 (Industry Ventures data).
• Paige notes that 74% of exit value has been from secondaries.
• Premiums for secondaries are rising, making opportunistic sales more attractive.
• Jason emphasizes the importance of selling at peak valuations, citing his Uber sales as examples. He sold some shares directly to the company at around $30/share and later to Masayoshi at $37/share.
• Jason has formalized a strategy to sell 10% of a position at 50x, 100x, and 200x returns.
• Megan highlights the pressure for DPI among GPs, noting that 75% of funds from 2015 to present haven't returned any capital.
• Megan explains "strips" (selling a percentage of every company in a portfolio) and "slices" (selling a portion of a specific position).
• Continuation vehicles are used to move assets into a new fund, offering LPs the option to participate.

2. M&A Activity and Regulatory Environment

• Jason observes that every M&A transaction during the Biden administration faced extreme pushback, citing the unwinding of the Adobe-Figma deal.
• He notes recent acquisitions by Salesforce, Sam Altman, DataBricks, Uber, and DoorDash, indicating a potential resurgence in M&A. These deals are typically in the $1-8 billion range.
• Paige mentions Zuck's 49% purchase of Scale AI as a way to navigate regulatory pressures.
• Jason believes Zuck's "49% hack" is a bad idea due to Meta's toxic brand image.
• Megan suggests that large companies with significant cash balances will find ways to deploy capital despite regulatory hurdles.

3. Founder's Approach to Secondaries

• Jason advises founders to control the secondary market for their shares by setting rules and communicating them clearly.
• He suggests implementing a process for employees and investors to request secondary sales, with a minimum holding period (e.g., four years for employees, three years for investors).
• Paige mentions QSBS holding requirements (five years) as a factor for individual investors to consider.

4. Challenges for Emerging Managers

• Emerging managers are defined as firms in their first three funds.
• Emerging funds raised $64 billion in 2021 but only $4.7 billion through May 8th of this year, indicating a significant collapse (Bloomberg data).
• Megan attributes the decline to liquidity issues, particularly among endowments and foundations, which are primary funders of emerging managers.
• Paige notes that the sales cycles for institutional investors are longer.
• Paige also mentions the opportunity cost of talented individuals joining AI companies instead of becoming emerging managers.

5. Y Combinator and Seed Valuations

• Paige mentions that YC companies are being told to hit 200k in MRR.
• Jason argues that the math doesn't work for seed funds investing in YC companies due to high valuations.
• Jason suggests that the best founders often don't take the Y Combinator deal.
• Jason's strategy is to find companies before they go to Y Combinator or those in the second, third, and fourth percentile that didn't get in, allowing him to make three bets for the price of one YC company.
• Jason criticizes the "handshake protocol" and high-pressure sales tactics used by Y Combinator, which can lead to unnatural acts and poor revenue quality.
• Jason found that some YC companies were sourcing their first customers from other YC companies, creating "round robins."
• Paige believes that YC has built a strong brand and community, but some people may be going into it for the wrong reasons.

6. Revenue Quality in AI Startups

• Paige emphasizes the importance of revenue quality and educating early-stage founders on startup accounting.
• She notes that reporting ARR should be based on annual recurring contracts, and marketplaces should report GMV separately from net profit.
• Jason observes that revenue quality is now a key discussion point, whereas it wasn't as emphasized in the past.
• Jason's diligence process includes asking founders about their first 10 customers, their usage, and their source.

7. Contrarian Investment Areas

• Jason is looking at AI-enabled services, where investors may see them as just services businesses and not venture scale.
• He also mentions hardware as a service as an area of interest.
• Paige is excited about Intramotive, a company building electrified autonomous trains.
• Paige is also interested in applied AI, consumer wellness and longevity, and deep tech.

8. Mega Funds and Seed Pricing

• Bill Gurley's tweet suggests that mega funds are primarily searching for companies they can invest over a billion dollars into, making seed fund investments collateral damage.
• Megan believes that the dynamics of fund size have an impact on the entire ecosystem.
• Jason argues that mega funds are looking for information rights to preempt billion-dollar checks, whereas seed funds are more aligned with the founders' long-term goals.
• Megan suggests that very large growth-stage funds are underwriting for 2-3x returns with zero capital loss, rather than the 5-10x returns expected in venture.

9. Stock Market Prognostication

• Megan predicts that the stock market will close above current levels this year.
• Altimeter is constructive on the outlook for the back half of the year, believing that the worst of the volatility is over.

Synthesis/Conclusion:

The discussion covers a wide range of topics relevant to the venture capital landscape, including the rise of the secondary market, challenges for emerging managers, the impact of mega funds, and the importance of revenue quality. The participants offer valuable insights and actionable advice for both founders and investors, emphasizing the need for strategic portfolio construction, thorough due diligence, and a focus on long-term value creation. The conversation also highlights the evolving dynamics of the venture ecosystem and the importance of adapting to changing market conditions.