Hi, I’m Connie Loizis. And this is Alex Gove. And this is Strictly VC Download.
Hello, listeners. Happy New Year. Can you believe it’s 2023? We hardly can,
but it’s so exciting. I have to say this has been a very long week. I know I say that a lot,
but this week has been really, really, really long for some reason. I’m sure the weather has
not helped. If you live in California, or you own a television or computer, you probably know that
we have been facing a pretty dramatic weather event out here this week that will continue on
through the weekend. And Alex and I, thankfully, we’re not spending the week in our galoshes,
trying to remove buckets of water from the side of our house as happened the last time there was an
atmospheric river. But it was still a little bit scary. So in between work, I’ve actually spent
quite a bit of time in my raincoat this week, trying to make sure that the homestead is safe.
In brighter news, it has been great to be back at work. Fun to see so much excitement
around OpenAI, whose co-founder and CEO Sam Altman has generously agreed to come to a Strictly VC
event next Thursday. I’m really, really looking forward to talking to him about a whole lot of
things. So stay tuned for coverage of that afterward. In the meantime, we have a couple
of news stories for you today. And we are also featuring an interview with Peter Wagner, a
veteran VC who some of you may know from his days with the Silicon Valley firm, Excel. Peter
co-founded around 10 years ago, another venture fund called Wing Venture Capital. And Wing does
a lot of interesting stuff, including most recently, to put together a list of some of
the top enterprise focused angel investors for its benefit and the benefit of everyone else who’s
investing in the enterprise space and wants to know who the right people are to get in front of.
We’re going to be publishing that list in TechCrunch. So keep your eyes out for that.
In the meantime, we also caught up with Peter about just a few broader market
trends that we hope that you will enjoy. And now some of those news pieces.
It was only a matter of time, I suppose. While the machines haven’t quite taken over yet,
in today’s Forbes, Thomas Brewster writes about how hackers are now using chat GPT to write reams
and reams of malicious software in the blink of an eye. Apparently, some cyber criminals are asking
OpenAI’s tool to create software that will install malicious code in an unsuspecting user’s computer.
Others have employed it to create their own drug marketplace, a la Silk Road.
And Alex Holden, founder of cyber intelligence company HoldSecurity, said he’d seen bad guys
plug chat GPT into chatbots on dating sites in order to keep conversations moving. Israeli
security vendor Checkpoint says the kinds of chat GPT malware they’ve seen have been pretty basic
so far, but they warn that the software will make it much easier for novice programmers to launch a
scam. However, an even greater risk than malware could be criminals who use chat GPT to orchestrate
social engineering attacks, which were responsible for 20 percent of all data breaches in 2022,
according to a study by Verizon. As Rick Ferguson, vice president of security intelligence at
American cybersecurity company Forescout, told Forbes, it could industrialize the creation and
personalization of malicious webpages, highly targeted phishing campaigns, and social engineering
reliance scams. I asked chat GPT what it thought about all this, and instructed it to write up its
reply in the form of a Shakespearean sonnet. Here goes. Oh chat GPT, I’m sorry, I can’t
hear you. Oh chat GPT, thou art a tool of great renown, a software that can write with speed and
ease. But in the hands of those with wicked clown, thou art a weapon, a dangerous disease.
Cybercriminals seek to use thy might to spread their malice far and wide, installing code that
does not seem right, and creating markets dark and hide. But worse than malware thou can create
is the power to orchestrate attacks so sly, to industrialize scams that mislead and bait,
and breach data with cunning lies. Oh chat GPT, thy power is vast and grand,
but be aware of those who seek to command.
Over the last decade or so, many VCs have built vast personal fortunes. Some of the money has
been made through investments in companies that have outperformed, but much of their wealth
traces to management fees that added up quickly as fund sizes, raised in faster succession than
ever in history, ballooned to unprecedented levels. Given that the market has changed and
will likely remain a tougher environment for everyone for at least the next year or two,
one obvious question is what happens now? Will the industry’s limited partners, the so-called
money behind the money, demand better terms from their venture managers, just as VCs are
right now demanding better terms from their founders? Well, if ever there was a moment for
the institutions that fund VCs to use their leverage and push back on how funds are raised,
or the industry’s lack of diversity, or some of the hurdles that have to be reached before profits
can be divided, now would seemingly be the time to do that. Yet in numerous conversations with
LPs this week, the message that I heard was the same. LPs don’t dare rock the boat and put their
allocation in so-called top-tier funds at risk. But what if they had more backbone? What if they
could tell managers exactly what they think without fear of retribution? What would they
change if they had their druthers? Well, for one thing, weird terms. According to one limited
partner, in recent years, so-called time and attention standards, which is language in limited
partner agreements meant to ensure that the people involved will devote substantially all of their
business time to the fund they’re raising, began to appear less and less frequently before vanishing
almost completely. Part of the problem is that a growing number of general partners actually
weren’t focused exclusively on their funds. They had, and they continue to have, other day jobs.
The LPs also said they found the hyper-fast fundraising environment fairly annoying.
Many of them were receiving routine distributions in recent years, but they were being asked to
commit to new funds by their portfolio managers nearly as fast as they were cashing those checks.
Indeed, as VCs compressed these fundraising cycles, instead of every four years, for example,
they were returning to LPs every 18 months, and sometimes even faster for new fund commitments.
It created a lack of time diversity for their investors. Said one manager, quote,
you’re investing these little slices into momentum markets, and it just stinks because
there’s no price environment diversification. Some VCs invested their whole fund in the second half
of 2020 and the first half of 2021, and it’s like, geez, I wonder how that will turn out.
Not last, according to several LPs, a lot of arrogance crept into the equation.
One of them told me that certain general partners would be like, take it or leave it. The LPs argued
that there’s a lot to be said for an even, measured pace for doing things, and that as
pacing went out the window, so did mutual respect in some cases. All that said, the limited partners
and others who fund the venture industry might grow less timid over time. In the conversation
you’re about to hear with Peter Wagner, for example, he observes that during the dot-com crash,
a number of venture firms let their LPs off the hook by downsizing the size of their funds.
Excel, where Wagner had spent many years as a general partner, was among those outfits.
Wagner doubts the same will happen now, but if returns don’t hold up, LPs could get fed up and
demand some concessions. Indeed, Wagner said he wouldn’t be surprised at all if
more favorable LP terms were up for discussion in the next year or two.
Up next, Connie’s interview with Peter Wagner of Wing Venture Capital.
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to net zero, go to sustain.life.com. And now, here’s Connie’s interview with Peter
Wagner of Wing Venture Capital. You have so many different interesting
deals. I see Vivo Therapeutics, which is this in vivo drug discovery platform,
DeepGram, a startup that focuses on building custom voice recognition models for customers,
including Spotify. How do you explain your mission statement to startups?
And what are you looking for in 2023? We think of our mission as helping people do
their best work. And so we do this in a couple of ways. One is by investing in companies that
are building out what we call the AI first technology stack. We’re big believers that
AI is not replacing humans, but that humans working with AI replace humans that don’t work
with AI. And so that set of products really empowers customers to do more and to reach
their full potential. And then for us specifically as an investor, we’re helping the founders that
we work with build the best companies and accomplish more than they otherwise would
be able to. That’s the heart of a great partnership. So that whole notion of helping
founders and their customers do their best work to the application of AI first technologies,
that’s really my mission statement. And that is a lot of what is driving enterprise technology
these days is how do I develop and apply that set of AI first technologies to drive business results?
And I think if you were going to highlight any particular super important movement in
enterprise, that would be it. The information I’ve written a pretty
interesting story, I think in late December about a company that focused on marketing, Jasper. It
was relying on OpenAI’s GPT-3 language model. And then chat GPT came out and it’s so strong
and it’s free for now. And it’s really causing Jasper to try to find new footing. And I’m
wondering if you are seeing ripple effects, I guess, specifically from OpenAI, but also whoever
is hot on its heels. It just seems like we could also see the network effects of these giant
companies getting bigger and crushing everyone else along the way.
Yeah. Well, crushing them or enabling them. The industry foundation models,
if you use that term to describe what OpenAI and others are putting there,
these are super powerful. But what it does is it creates opportunities for startups to build
around them and on top of them and add value to them. This makes those models more useful
in specific use cases, more useful to specific customers. So I think of just the amazing
developments amongst these foundation models is like the creation of the microprocessor,
the creation of the PC. And these were enabling technologies. Did the emergence of the PC
destroy industries or allow new ones to come into being? A little of both, but much more on the
latter. Right? Right. Think of all the companies and the different types of software products and
other industries that were born because of this enabling technology. And so somebody like Jasper,
just to stick with your example, they need to figure out how to add value around the OpenAI
family of models. And if you can’t do that, then you don’t have a company. But I think what we’re
seeing is that many founders are finding ways to extend and add adaptation layers and workflow
around the foundation models to really drive business outcomes and users will pay for that.
Also, in terms of these foundation models driving business outcomes, I would assume that you need
fewer people because of the power of these models. So is that being reflected in the amounts of money
that people are raising? People in the startup, you mean? Yeah. Well, you certainly don’t need
people going and recreating the work that OpenAI has done, but you need people doing other stuff.
So again, if I go back to my chip analogy, it used to be, if you were a computer company,
you had to develop a microprocessor. That was part of what IBM and Digital and others that
preceded Intel were doing. But then when commercial microprocessors came out and became sufficiently
powerful, then the computer industry no longer was spending time developing microprocessors,
but they were developing a lot of other things added up to a more complete product, a more usable
product. So I think you’d see resources shift. They take advantage of the enabling technology
and then their resources are allocated elsewhere. So I don’t necessarily think it means that
there’s fewer people in the company. I think it means you’re doing different things. I would
certainly at least hope so, because if that’s not the case, then it might be that your value
add is relatively thin. Right. And then Peter, just heading into 2023, what is changing? Are
terms changing much at the seed level at which you’re playing? Are valuations much more reasonable?
Are you concerned about the economy right now? Do you think it’s going to be a slow year or that
we’ll be fine in another six months? Well, I don’t think it’s going to be fine in another six months.
I think we’re in for a bit of an extended bottoming period. I don’t know exactly how long,
but if prior experience is any guide, we could bump along in a bottoming period here for a year
or two. That doesn’t have to be doom and gloom though. If you look back historically, many of
the best companies that were really of enduring value, they were actually built or formed, I should
say, during these bottoming periods. So if you look at say companies that were founded in 2002,
just to pick a cohort, that ended up being a particularly exceptional group of companies.
And so why is that? Well, one is, I think it has to do with founder makeup and the makeup
of the early teams. These weren’t tourists. They knew it was going to be difficult. So
they were doing it with the right mindset, fully expecting some challenges, prepared to take on
those challenges. You might say they were gritty and hearty and pure of heart. And then the way
the companies were built, they had to be very frugal and they had to be focused on value
propositions that made sense even when customers were being really cautious with their spending.
That level of focus and that level of efficiency and that level of clarity around the value
proposition pays dividends over the long term. So I think this is actually a really good time,
not breathless and prolific time, but can be a really productive time to be starting companies
and investing in early stage companies. But you have to know what you’re doing. And I think it’s
a little harder to read some of these signals than maybe when everything is going up into the right.
You know, terms are certainly resetting. Deals are not closing in three days, but I think this is
healthy. It’s allowing founders to get to know their prospective investors in a more substantive
way. It’s allowing investors to do high quality work, standing the opportunity. So those don’t
have to be negatives. Do you think we’re going to see firms raise smaller funds all of a sudden,
or maybe just space out their fundraising? Well, I think certainly there’ll be spacing out. That
was really unhealthy. The idea of coming back to raise a new fund every year or two, that type of
time compression is not good for anybody. So we’ll certainly see that. Will the funds themselves
shrink? I’m not so sure about that. What drove the increase in fund size in the first place?
Part of it was a proliferation of strategies. We saw especially big venture platforms expanding
their product lines, you know, sector funds, growth stage funds, international funds of
various sorts. And I think that’ll be sticky in many cases. I think we will see deal sizes
perhaps normalize a bit. So the really enormous late stage financings might… What’s the term
you use in Strictly VC? Oh, big but not crazy big fundings? Massive fundings? Yeah, there’s
that whole hierarchy, which I find very funny, right? So maybe we’ll see everybody move down
a click in your hierarchy. But the huge fundings were supply side driven, right? It wasn’t that
the companies needed that capital. And a lot of that capital is still sitting on balance sheets.
It was really just because investors were trying to deploy capital that would only be accommodated
by the companies because the terms were so favorable to them. As terms reset, there’ll
be less appetite for the really huge round and you’ll see less capital deployment. So I think
that’ll certainly happen. If you go back to the early 2000s after the dot-com bust, we actually
did see large fund size reductions. And not only that, but we saw capital that had been raised
actually released. So maybe somebody had raised a billion dollar fund and turned out they couldn’t
invest that. Well, Excel, you were with Excel and Excel did that. Yeah, absolutely right. Yeah. And
so we ended up releasing a large fraction of Excel 8 and other firms did the same. But I think what’s
happened now that was different then is you have people on a multi-strategy approach. At Excel at
that time, we were a pure play around early stage. Excel today, you’re doing growth stage investing,
you’re doing a number of different strategies. And so I think you’ll have maybe capital finding
new strategies. And I’m sure you probably even reported on this, how some managers were
deploying into the public markets with capital that was raised. I think that’s a bad idea. If
I was an LP, I wouldn’t be happy about that. But I think that’s just an example of that capital
is more likely to be deployed in different strategies than it is to be released.
It’s a really interesting point because I was wondering six months ago, I guess,
if we were going to see some of that and I was waiting and obviously nobody has made a similar
gesture as Excel did 20 years ago. And maybe that explains it. They’re just finding other
ways to put that money to work. And so not returning it. It may be that the returns will
be poor. And so then perhaps future fund cycles will be less well-received because of a move like
that. But as you know, that takes quite a number of years to play out. LPs have to be very careful
about not burning bridges. And so it’s hard for me to imagine that they’re going to be asking for
better or different terms than they’ve been receiving, except maybe for the poorest performing
managers or possibly, unfortunately for newer managers who don’t have much of a track record.
But I’m just wondering, can you imagine them using this moment in the same way that VCs are
telling their startups, look, we expect better terms here. Do you think that LPs would find the
backbone to say to VCs, look, we want better or different terms here? I think that could happen
in some cases. And again, it takes a while for this to play out, right? It’s usually the next
fund cycle when that conversation can come. And if the next fund cycle is several years from now,
we might be in a different economic environment. So perhaps the moment will have passed,
but I wouldn’t be at all surprised if that was under discussion in the next year or two.
Well, I really appreciate your time and it’s great to catch up for a few minutes. And I’m
excited to take a longer look at this list that you’ve put together. And I’m sure again,
that readers and listeners will be excited to see it. Cool. Okay. Thanks so much, Connie.
That’s it. Thanks for listening. And a special thanks to sustain.life. Please check it out
at sustain.life slash StrictlyVC. Have a great weekend, stay dry, and we’ll see you back here