94. What’s Wrong with Venture? Part 2 (Dave McClure)

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Today we cover Part 2 of “What’s Wrong with Venture?” with Dave McClure of 500 Startups. In this segment we address:

  • Dave McClure What's Wrong with Venture part 2Are there any problematic issues that you’ve observed w/ founders?
  • Any thoughts on who might be one of the most misunderstood people in the venture ecosystem?
  • How do you think about the landscape of accelerators and how do you differentiate at 500?
  • Any other comments on challenges in the venture environment and what you’d like to see change going forward?
  • On the other side of the coin, what positive trends have you observed in venture over the past few years?
  • What startup investor has inspired and influenced you most and why?

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Key Takeaways:


1- Lack of innovation in VC

Compared to building a business, investing is just not a lot of work.Dave talked about how the effort for VCs is concentrated on getting the fund raised. After that, most of the job is about taking meetings and saying no, with the occaisional yes. There’s a lot of folks that make a good salary on management fees whether or not they have a successful fund and receive a carry.

Because of that, a lot of the way VC operates now is not very different from how it did 30 or 40 years ago. And Dave believes that the generalist VC is going away. Going forward there will be more:
sector focus
business development

He sees much more competition and differentiation in the future, amongst the VC ranks.

Another issue, combating progress, is related to LPs. Dave said that LP influence over fund strategy may not be positive; but it’s also not a new trend. And those early and new fund managers, that one might think should be most innovative, are also more likely to be easily influenced by LPs. This results in fund managers that will move their strategy toward the sexy trend of the day. So those that should be driving change, end up as fast followers.


2- Fundraising Concerns

When discussing concerning trends in the fundraise environment, Dave mentioned both early and late stage issues. First, let’s review the early-stage…

Early-stage issues:

1.More Convertible Notes at increasingly higher caps

Dave has observed, over recent years, that many entrepreneurs are raising more than $1M on convertible note structures. And when these founders eventually get to an equity terms sheet; the conversion may not occur w/ reasonable expectations. They may expect to be giving up 10-20%, where they’re actually giving up 30-40%. And then there are those that raise on a convertible but never get to a subsequent equity round. Convertibles are debt capital, not equity, which brings another set of issues if conversion fails to occur.

2. Increase in Seed Investment

We also discussed the influx of new angels, new seed funds and much more capital at the early stages. Where there used to be handful of seed funds, there are now over 100. But Dave doesn’t see this as a major problem. While newer investors seem less sensitive to valuation and have less experience, this, overall, has had a positive impact on the ecosystem.

Late-stage issues:

1. Influx of non-VC capital

When discussing the recent reduction in valuations, particularly for SaaS, Dave’s opinion was that they’ve come back down to a more rational level. For a period, they were inflated and new entrants were driving some of this valuation increase. We’ve talked about this a number of times in the newsletter and venture weekly. Many late-stage private companies have stayed private longer, and grown faster into multi-billion dollar companies. This restricted the supply-side of growth tech companies in the public markets and caused much more demand for investment in late stage private companies. With this, a host of new players started investing in late-stage venture. Corporates, private equity, hedge funds and large financial institutions all became active financiers in the venture market. And this led to the second issue we discussed, which was the:

2. The Late-stage, dirty term sheet

While a number of these later stage investors became less valuation-sensitive, they also protected their downside. By including lots of structure or liquidation preferences, they’d could ensure that if the company raised again, or went public at a lower valuation then the current round, they would still get the return they needed. So they were playing both sides. If things went great and the valuation continued skyrocketing, they win. If things go poorly or flat, then they still get their healthy liquidation preference and the previous investors, namely the common stock holders (ie. founders and employees), lose a lot of their return. This is where the infamous Full Ratchet rears its ugly head. While full ratchets are typically less common or concerning at the early stages, they have become a preferred method for late stage investors to capture more equity.

3- What’s Going Right with VC?

Despite today’s controversial topic, we did also discuss what’s going well and who’s driving positive change.Regarding innovators on the investment-side… Dave mentioned 500’s efforts to have a much more diversified portfolio, both in volume and diversity of investments.

Others in the industry that he feels have been innovative include:

Y Combinator

Series A
First Round

B or Later
Google Ventures
Andreesen Horowitz

Dave mentioned some positive trends in venture including:

-VC has become more International
-There’s significantly more tech infrastructure and plumbing for entrepreneurs to build on
-It’s become a lot cheaper to build a startup
-It’s easier to get the information required to build and grow a company
-And, in general, entrepreneurs are smarter and more educated about the entire process


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