418. Why Market Size is Irrelevant, Patterns from Working with the Best Founders, & How AI Compares to Past Paradigm Shifts (Gaurav Jain)

418. Why Market Size is Irrelevant, Patterns from Working with the Best Founders, & How AI Compares to Past Paradigm Shifts (Gaurav Jain)

Gaurav Jain of Afore Capital joins Nate to discuss Why Market Size is Irrelevant, Patterns from Working with the Best Founders, & How AI Compares to Past Paradigm Shifts. In this episode we cover:

  • AI Paradigm Shift and Its Impact on Venture Capital Investments
  • AI Investment Opportunities in Various Industries
  • Market Size and Founder Potential in Seed Investing
  • Evaluating Founders’ Ability to Learn and Grow in a Fast-Paced Startup Environment
  • The State of the Pre-Seed Market and the Importance of Innovation in Venture Capital
  • Startup Funding and the Importance of Right-Sized Rounds

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Transcribed with AI:

Our guest today is Gaurav Jain, the co-founder and Managing Partner of Afore Capital. Afore Capital is an early-stage venture firm headquartered in the Bay Area focused on pre-seed investing with nearly $300M under management. At Afore, Gaurav has led investments in Modern Health, FlatFile, and Neo to name just a few. Prior to founding Afore, Gaurav was a Principal at Founder Collective, where he sourced or led investments in Cruise, Firebase, and Airtable.
Todayโ€™s interview also has a different format. Gaurav and I began casually contrasting the current paradigm shift in AI as it relates to cloud, mobile, and the internet and we decided to just keep the conversation going
So, without further ado, please enjoy the conversation with Gaurav Jain,
I’ve been doing a lot of thinking about the paradigm shift with AI and where value is going to accrue and comparing it to the past paradigm shifts with desktop to mobile on prem to cloud. It’s interesting. It’s like the first software to software paradigm shift, where a lot of the other paradigm shifts in the past, were driven by some sort of hardware catalysts, whether it was a net platform like your mobile device, or the accessibility of your PC, obviously, on premise to cloud, there’s a lot of hardware that underpins that, regardless if people know that or not. Yeah, so I’m with you, I think there’s going to be a lot of value that’s going to accrue in these areas that haven’t adopted technology or haven’t been as interesting to invest in from a venture perspective. Like we’re already seeing that in legal tech, a lot of unstructured data. All of a sudden, three, three years ago, no one wanted to touch a legal tech today, a lot of money pouring into it. So I think it’ll be pervasive across other industries.
And adoption will be far faster. Because that reason GPT was like the fastest product to grow, right, I think in the history of products is because you didn’t need a new piece of hardware to interface with an experienced set up to you did was access to the internet, which, you know, is already there. So I think that’s why AI will be everywhere much faster, which I think does beg an interesting question isn’t incumbents opportunities? And newcomers? I’m sure we’ll get into this. And I think that’s good. That’s that’s something we think a lot about, obviously, because, you know, we’re only investing in started. Comments, right? So you want to understand kind of where, where the valuable accrue, yeah,
actually wanted to talk about what your thoughts are on is, I’ve been hearing a lot about a business model more centered around the work, versus a seat based license or a metered service, whatever it might be. And I want to hear that I wonder if like that’s orthogonal enough to display some of the existing software incumbents versus the shift from on premise to cloud was high upfront costs for software, you have the servicing fees versus a very orthogonal shift. It’s like a new company architecture around SAS base pricing model, right. And I’m curious, like, when you guys think about disrupting existing software incumbents? Do you think it will be around business model? Or do you think it’ll be something else? Whether it’s, I mean, the product architecture, isn’t that different from what we’ve seen from co pilot, but I guess, what are the vectors that you guys think about that could potentially disrupt incumbents?
I’d say business model is one of several vectors, in our opinion, and I’m not sure if you’ve kind of lead with the business model. I think that’s sort of the tail wagging the dog. I think the important piece is Majan, new set of use cases or new customers, right, new markets that could I guess, going back to like the Clay Christensen, you know, theories of disruption, right? So the new market going after, would that where the companies don’t want to go after, I think that is, in my opinion, even more interesting, right? Because AI may decrease the cost of servicing a certain customer that just wasn’t possible before, because you needed a human in the loop or something else was expensive. Whether you needed a human in the loop on the vendor side, or the customer side. But now with AI, maybe that becomes automated, I think that is really interesting. And then you can figure out the business model to monetize. Because you cannot do if it’s like fully automated, there are no humans involved. How do you charge for that? Right? I think that’s where you charge probably based on work and not not seats. Because again, that makes no sense if there’s automation at the front end cetera. So that’s what we were thinking about, because some of the incomes may be able to pivot right where they can adopt AI because it’s essentially API right? It is not massive technology shift right. So they may be able to doctor from product side they may be able To pivot into the business model. So we think that in and of itself may not be enough, right? I think you have to kind of look at places where the incumbents are just not focused, because I can tell you whether small companies or big companies, they’re all hands on deck right now in AI, and trying to think through how they leverage the distribution to be able to make sure they don’t miss the boat on this. So I’m not sure if you go head on with a similar use cases, a different business model may not may not be enough, I think it’s necessary but not sufficient.
Yeah, I totally agree. Because when you look at past paradigm shifts on premise to cloud, eventually, Salesforce overtook Siebel. But Siebel was focused on the enterprise. And then Salesforce enabled other market segments who adopt software that had never been able to before because people couldn’t service those customers in, you know, using the business model that they had adopted. And, and it was just too expensive for an SMB to stand up a server in in their office. So I agree, like, and then another example would be the whole PC verse mainframe PCs were sold to consumers initially, and then eventually made its way into the enterprise 10 years later, but they never go head to head right away. And if we don’t look at history, and look at how past paradigm shifts have evolved, I think we might miss the bigger picture, you know, to your point about where value is going to occur initially where these opportunities might find kernels of value, and it’s probably going to be in areas that technology or software hasn’t reached, or at least penetrated to the same degree that we’ve seen, you know, with other paradigm shifts. So I guess if it gets a bit gets a question, when you guys were talking internally, what are some of the markets? What are some of the areas where you guys where you think this, you know, this model could take place? What are some of the markets that are the most interesting? Yeah, you
know, at a four, we tend to be a lot more founder focused, and frankly, sector focused, because we’re investing in the idea kind of MVP stage. Right? So it’s very, very early. And what we look for are more phenomenons than markets per se. Right? So really trying to understand at the ground level, what are these founders pointing at that may not be very large today, but has the potential to become large? And a lot of cases these look like toys, right? These look like bad ideas? Right? Because it feels very much like a feature not a product or feels very Nishi and that is what gets us excited to begin the diligence. And of course I do do I have a point of view on how sort of that toehold becomes a foothold becomes like, you know, you’re all in, in those are in arguably the best investments, because these companies take a while. Right? And I think you want to be early, but not too early, but also not too late. Right? I think you’ve to kind of time the market perfectly. And look, obviously AI we think becomes a horizontal just like you know, we don’t talk about internet companies anymore, which is every company in tech, you’re not investing in our internet, it’s sort of by default, similarly, within AI becomes that. So the question now is like, what are interesting use cases or jobs to be done that that AI will put an enable, and that’s everywhere. Obviously, you start off with industries that are more more vulnerable to like an LLM, think of like, legal right document a document out, right? Healthcare that has a lot of data, right? Where you can glean insights that today are just not possible, you know, manually. And I think over time will go after every interest rate is slowly and steadily given you think about voice becoming a very interesting element. Now, you know, in with voice, I’ve got young kids, you know, they obviously start to talk before they can write. Right? And like now, can you imagine like what that could unlock right? We can our senators, only two and a half is like learned how to use you know, of course, like every screen possible to the point where things a TV is also a touchscreen, because like that’s what they learn first, and they learn to talk and like he started doing interact with the Google homes in the house. And like, if that was much more powerful, which these will be over the next few years. Like the vast that’s amazing, right? You can imagine like a AI Danny, you know, where somebody could I mean, today, he’s all over coca melon, can you imagine something even more, you know, engaging and something that’s where he’s learning and like, essentially a teacher, but I can engage in teacher not a one directional conversation, but like a bi directional. So I think there’s a lot of interesting things get unlocked that just weren’t possible before because of this incredibility ability to process unstructured information in real time, and then get really interesting responses and kind of rinse and repeat. Yeah,
it’s one of the things that you mentioned, while you’re speaking, I want to circle back to is the element of timing. So you’ve invested for more than a decade, and we were talking about how AI is really the first software to software paradigm shift where it’s not a new distribution channel as it was with mobile, for example, which has changed how quickly the Companies can penetrate whatever market respective market they’re targeting. How has your view of timing shifted when you’re analyzing an idea stage startup and analyzing where the startups opportunity falls on the spectrum of it being too early versus too late?
Yeah, for sure. You know, I borrowed this two by two from Chris sticks. And he talks about in the on the axis of like, what looks like a good idea. And what is a good idea, right? If it looks like a good idea is actually a good idea. It can work but it has to be too competitive. And I think that’s where a lot of the AI co pilot stuff, it’s right, it feels like okay, like somebody should build this, it should exist, but not sure if it’s a venture back at all opportunity, because there’s just too many players incumbents will try to build their CO pilots just on the freakin value, then there’s sort of these like bad ideas that are that look like that agents actually bad ideas, you obviously want to stay away from that the real value creation is where, you know, it’s actually a good idea, but looks like a bad idea. And I think that is a function of different bunch of different things. One is we were talking about earlier, you know, it may not be it may look like a feature or small idea. But sometimes it may look like it’s too early. And I think this is where our job comes in. Do you understand? Is it actually too early or not? Right? Because the challenge you face if you’re too early, is it’s harder to attract downstream capital, right. And, of course, venture backed companies and ones that have great outcomes end up raising multiple rounds of funding, right? Because you want to continue accelerating, you know, going from milestone to milestone, right. So that’s what we try to assess is, and that’s obviously an art more than its science, right? So for example, when we invested in modern health, right, almost six years ago, at the time, the mental health wasn’t that new concept, but it was still in the fringes, right? It was still a taboo to talk about it. But you know, when I reflected on my own mental health journey, or talk to friends or talk to especially companies, they were starting to like, become attuned to the reality of mental health that is as important if not more as physical health. So you can sort of see this inflection point to the fact that a society were turning a corner. So it felt like it was not too early. I think if 10 years ago, you tried to build modern health might have been too early, because there just wasn’t enough appetite in the customer side to buy that product. And hence, that wouldn’t be happening on the investor side. But today is I think, too late to start a company mental health, right, because there’s way too many players, unless you come with a very net new insight, I think it is really hard to build something because a lot of the incumbents have distribution already built in. And it’s hard to sell a new product when customers already have bought something so that we tried to sort of assess that by talking to customers, frankly, more than anything else, we’re what you want to hear is like, this wasn’t on our radar a few years ago, and it’s like slowly become on the radar. And now it’s like starting to become a top three priority. Or we can see that this becomes a priority in the near future. I think that’s what you want to hear. And it’s fine. If it’s just some early adopters that are saying that, but you can kind of see the early adopters have a good experience, the rest will follow. And I think that that just happens by by just being get out in conversation with with customers with folks that we use the product.
Yeah, that makes sense. I, one of the things you had mentioned before the show was how you think about market sizing and simply saying it doesn’t matter. I was wondering if that is an opinion, you’ve formed over time versus learning some hard lessons on initially thinking some opportunities were too small, and they end up having grandiose outcomes, or how has your opinion of market size evolved over time because Founder Collective one of the best seed firms out there, I’m sure you have learned quite a few things from working with David and Eric over there, but specifically around market size. I’m curious what your learnings have been, and how you assess the size. I learned
that the hard way. The best example I could share with you is a company called carta that many folks have heard of when Henry the founder, CEO pitched me visionary twice, actually, I passed and he came back again to pitch me again, it used to be called E shares back that and the idea was was simple, right, which is cap tables, right usually are sent back and forth in Excel, they’re maintained manually. What if we digitize that? Right seems like a pretty good idea. Okay, that should be that should be digitized to make sure it’s accurate. It’s easier, just like Google Docs, you know, you can sort of collaborate and so on and so forth. But what frankly I struggled was market size. But my failure there was the was I couldn’t imagine how this wedge product then ends up opening adjacent markets for E shares. That was my failure of imagination that Henry clearly could see that that obviously other investors were able to see. And that has been it. There’s other examples like this too, thankfully, some were I was able to use that lesson and apply that and invest that I could talk about some of those as well. But think about it because again, I’m investing in like seed, you know, idea stage inception stage, right so it’s It’s unclear exactly what the large market will begin. In my opinion, the best companies either expand markets in ways that even the founders can’t predict or shrink markets, right? In some ways, and I’ll talk about both examples like Uber, right, which my previous fund federal collected, invested in, you look at their, their their seed stage deck, it says the TAM is like $4.2 billion. Right. And usually founders, like, you know, exaggerate market size, I don’t know what the founders really thought that market size was. But 4.2 was like their wild imagination, market size, Uber today has 10x of that in revenue a year. Right. And that’s just Uber. Right. And it’s not because the founders be conservative, because they’re anything but but it’s because these are the initial wedges, like black Congress, like that is what we want to focus on. And that was a $4.2 billion market. And it’s once you start executing, and this is what the best founders are able to do, they’re able to expand their imagination as well, they’re able to expand sort of that world domination plan. So the combination of like visionaries, but also can execute, right? Because I think if Uber had come in and said, We’re gonna like transform transportation, harder to buy that story here now, because it’s like, wow, that’s a massive leap to go from, like, you have no background in transportation to like wanting to do all this stuff, I think it’s easier to buy the story for both the founders and for investors to say, we’re gonna own this in a more manageable market. But to the best founders say, Well, I don’t have to stop there. Right. What can I do that are just adjacent to my to my market? And hence, I think it’s both a combination of like, you have to imagine along to the founders, but also assess the quality of the founder. Is this the kind of founder that can go from strength to strength? And hence, we’ll just keep expanding the market opportunity? Or is this a founder that sort of has a ceiling on their entrepreneurial potential, and there’s also companies that, frankly, shrink the market, you think of Google as a really good example, right? The adage historically in advertising was at 50 cents of the dollar, every dollar I spend in marketing and advertising is wasted. I just want to wish 50 cent, right. So you throw a bunch of money and like TV advertising, you have no idea who’s watching it, but you got to do it. You know, incomes, Google performance based advertising, and you’re exactly who’s clicking on your ads, you can exactly tell if people are buying or not. And hence you can be more efficient with your ad budget. Right. And again, those are those are things that when founders just execute beautiful, A, the markets get warped in very wonderful ways. And I think that’s why you cannot get too stuck on what the market size looks like today, too, as to underwrite these opportunities. Yeah, we’re
Founder Collective did Uber.
Right, right. Yeah, that’s right. Were you there when Yeah, this is before my time. So I can take zero credit for that for that investment. But I got a chance to see the the wild ride of who joined in February 2012, when Uber was still not a household name, far from it, if you were only doing flatcars at the time, but then I got a chance to just see how that company has kept expanding their Tam. And frankly, internally, we would sit around and go like, wow, like this, this new round, whatever round was happening, whatever crazy valuation that seems like, that seems like the top, you know, for this company, and every single round, you felt the same thing. And arguably, maybe we’re still in that zone right into the company is is far north of where it went public a few years ago, I just joined the s&p Like, he that’s what amazing companies do is like, you just you just can’t get a strong grasp on how big this can be.
Yeah, I the reason I was asking is I was curious if you are privy to the conversations around markets eyes, because it anyone that is really looked into Uber or heard the proverbial stories at the early stages of why investors pass it was 100% market size, or that’s at least what they point to. And I was, I was wondering, you know, there’s some lessons to be learned there. One of one of which I heard is analyzing consumers behavior at the atomic unit. So how many cabs are you taking per week per month? You were taking one? How many Ubers? Are you taking now? Oh, you’re taking three per week, there’s clear expansion just within that customer, then if you can size how many of those consumers or are you can theoretically understand that it might have the potential to expand market size that that’s perhaps one learning. And so when you’re assessing
hindsight, 2020 I don’t buy that a today. Yes, you can underwrite that, but at the time, they were only pitching black cars, and most people cannot take three black cars a week, you know. So I think you have to Android the quality of the founders at this stage and believe there’s enough juice in this market to get the first space where they can then earn the right to raise more money and build something new and interesting that we can’t imagine today. Right? We predicted it what exactly that’s gonna be I think, underwriting and model at the stage where our Founder Collective invested, I think that’s like, that’s like having a crystal ball that
this is totally investor hindsight. 2020, right, where they someone hits a winner, and then it’s like, what did you see? And it’s like, oh, he was my very scientific algorithm for how I diagnose that Uber would potentially have 100 billion market cap one day, right.
I think if that was possible, source would be at every amazing company, right, that has had a similar trajectory. And I just think the reason most investors are not in every single one of them is because it’s impossible to predict this stuff. Yeah.
Yeah. So maybe let’s let’s talk about founders and their ability to continually expand market size. That was the the other area I wanted to circle back to. So what are some of the patterns that have emerged over your past 1012 years of working with? I don’t know how many unicorn founders that is exactly. But you’ve worked with quite a few founders that have grown significant businesses, what have you found in terms of patterns across those that have really broken out, expand in market size growing fantastic teams?
Yeah, I’d say if I can use one word, it is learning. Right? If I can add a little bit more color, it’s their ability to learn quickly, it’s their pace at which they’re willing to get out there, talk to customers, talk it be in the industry, gather feedback, you know, digest that, build product accordingly, and just iterate really, really rapidly. You know, so the best founders in our portfolio, frankly, started here, ended up here, they just learned really, really rapidly What did before they ran out of money, right? The companies that haven’t done so well, it’s actually rarely been because of market size. And the reason I know that is because a competitor came into the same market and crushed us, right. So I know, it wasn’t the market opportunity, because that was available to us as well. And we were there early, it was just we could not execute the way that the competitors did. And on the flip side, the founders that do, and it’s really in this is more limited to venture backed companies, right, and not talking about broader, you know, ecosystem because of course, if you’re a bootstrap business, if you’re building a more traditional business, and you want to build it, you know, at brick by brick, you want to generate cash flow, you want to invest that back into business, that’s fine, right? I think in these venture backed businesses, where it is about hyper growth, right, which is the reason you’re raising money is to accelerate enable that hyper growth, I think there that learning pace has to be even faster, right. And I think that that is very, very critical. It’s also founders, frankly, were willing to be vulnerable, right? Or willing to like, I’ll give you an example of founders, there’s definitely correlation between the ones that send regular updates. And the ones that do well, we find out Yeah, the regular updates, what that’s doing. It’s not about like governance, I’m not I don’t want to read regular updates. So I can be like, Oh, I’ve done you know, we’re not hitting a number. That’s not what it is. But it’s actually for the founders. Because what that does is it it helps you in a few ways. One, it holds the founders and the team accountable. Right on, we said we’re going to do this, did we do it? If not, then what happened? Right? What’s the diagnosis? And like, let’s course correct before, it’s too late, right, number one. Number two, it sort of puts this, it makes sure the cycle times are short, right? Because if you’re sending monthly updates, and frankly, I think founders should be sending weekly updates internally, at least within their team that allows you to just like set that pace of execution to be like we should be making meaningful progress month to month for not like what’s wrong, right? Because again, we’ve chosen to be on this hyper growth path. And our progress has not not aligned with that. And it also just shows vulnerability, right? I think it’s really, really important for founders to be comfortable putting themselves out there, right? When you talk to customers, and you have just an MVP, that’s an incredibly vulnerable position to be right, because chances are people are not gonna like it, and it’s your baby, and nobody wants to hear their baby’s ugly. But I think that’s important, right? That’s really, really important. And you have to be vulnerable that to your investors to be like, here’s what’s working, here’s what’s not working to your team is that is a very important trait. And this is like one anecdote of what we see in like, really good founders. But but I’d say like, just ability to learn about new markets about what their customer takes their customers. And also like, when it comes to learning, like understanding the customer holistically, right, not just like what you’re selling, but what motivates your customer, right, what incentives do they have, and incentives drive behavior, like, again, just that incredible curiosity, to learn and to be able to, like apply that to your company and product? What are the biggest learnings for us?
How do you assess learning when you don’t have a long longitudinal view of the company’s life because you are investing at the idea stage? They haven’t been around that long. So if you’re meeting the founder, let’s say for the first time, you didn’t know them, from prior experience, what goes into that process to assess their capability to learn quickly, to have that open mindedness to grow to the degree that you’re that you’re talking about?
We do a bunch of different things. One, a lot of back channel right with folks that have worked with this person before. Understanding what it’s like what their what their orientation is everyday is their orientation to bias for learning bias for action? Are they more, you know, ladder climbers? Right? It’s more political, right? It’s more about, you know, perceptions. And by the way, there is a place for that. And that’s big companies. And those folks do really well. That’s great tend to not make great founders, right, great founders tend to be more rule breakers and, and are just very motivated on like, I gotta appease the customer, I got to build something that people care versus pleasing folks, internally, I think back channel tends to be a really an triangulating that right across multiple people. I think that’s where having been in the network now for a decade plus really helps, because usually, you know, we can get in front of people and they worked with fairly quickly. The second is also just kind of a tracing their trajectory, and this and the and the path of how they ended up here, right? Because usually, even when we invest, it’s not like they thought of the idea this morning, right? It’s usually that, you know, three months ago, six months ago, they were at their previous employer light bulb went off, maybe there’s multiple ideas that they were kind of considering, and then just sort of tracing that to say, what did you do to like, validate this idea or invalidate this idea? Who did you talk to? Right? Why, and like really going deep on that? I think there’s no right answer to these things. But you’re just sort of seeing that, that that pace of learning, I’ll give you an example, actually, recently, there’s a company that pitched me in the healthcare space, I really liked the founder, but didn’t like the idea specifically. And I said, give them that feedback. And I passed, that came back about a month or two months later, and they’re like, Hey, not going to change your mind, because I know you already passed. But here’s what we learned. And actually, we were gonna go in this direction, which is adjacent right to what we were building. I was like, you know, what, just the fact that you’re like, open to that learning and doing so fast, I’ll take every single call, even though I thought maybe it probably wouldn’t get there. She ended up investing in leading that round. Part of it is for me, that new idea, I was really compelled by it. But also, that’s the kind of team I want to back that is going to go in and let the customer lead the dance. Right and not try to jam something down to the thing the customer needs, but let the customers sort of, you know, point to where the opportunity might be. They can sniff commercial signals. I think that to me, is a very important, you know, characteristic for founding teams. Yeah,
yeah, absolutely. I, you know, I want to shift gears a little bit. And I want to hear what you’re seeing in the PC market today. How would you assess the state of where we’re at today, on the precede side? You
know, preseason, interesting term, when we started a four, but almost eight years ago, precede was a negative term, actually, it was reserved for companies that failed to raise a seed. So founders didn’t really want to call the round three seed. And certainly investors one had nothing to do with pre seed, because they were like, hold on. So companies that I pass on, that’s what you’re gonna invest in pre seed, thanks. Like, this is great. It’s amazing. In eight years, it’s gone from negative to like, now a huge positive, I mean, vast majority of founders, I put their hand up and say, yep, I’m raising a precede. And now every early stage investor claims to be doing precede. And that’s, you know, for us just a manifestation of the problem, the gap you saw in the market, right, which at the time wasn’t really called being called precede. But the gap in the market was, you know, being able to raise the first one to $2 million risk capital, but you’re just at the idea MVP stage, right, most investors wanted to invest, but there’s some traction or sometimes a lot of traction. And if you look at historically, like in the last few years, 95% plus capital has gone to growth stage right. Now, of course, that may change in a lot in the future. But that is that has been the case, a lot of mega rounds, and so on, and so forth. So we saw that that gap, we can leave it on that made it exclusively precede fund that’s not do PCs as a call option. And I think founders really resonated with that, because that was a real, obviously real gap in the market. And they were like, look, I don’t want to, you know, have to bootstrap until I can, I’ve got a few indicating IRR. When I can raise a seed round, I want to be able to raise money now. So I can go because I’m all in and I want to move fast. And I see the opportunity. In years later, there’s obviously a lot more players in the ecosystem, right funds that also do precede shedding is great, because there’s a lot of companies getting started. And arguably, you know, AI is accelerated that pace. So there’s no need for more people to help these founders. But you know, in our opinion, the best best businesses, whether that’s a company we invested in, or whether it’s venture firms keep innovate, right, keep trying new experiments and sort of shifting as a market shifting around that versus staying in one place. And you know, what, we started off with a hypothesis and the last eight years worked really well. And that’s great. And I think now we’re starting to think through what’s the next frontier for us, right? How can you serve as founders in a more meaningful way moving forward. And we recently launched this program co founder and residents, right where the idea is, if you think about a founder journey, right, as we were just talking about, you know, you don’t just like wake up at them. Morning you and idea your fundraising in the evening. Now you take a few months to like, try a bunch of different ideas, find a co founder and build conviction yourself, right that this is what you want to do for the next decade plus of your life, that is a very, very big decision, right? A very high stakes decision versus, you know, staying employed or finding another job or joining a high growth startup. So federal residence does is to focus on that stage, right and say, How can we better service these founders? How can we help them build conviction? How can we help them get in front of customers, or connected co founders, and so on and so forth. And we think in some ways that sort of evolves into what precede may look like moving forward, right? Where it is about not just investing in companies when they’re ready to raise, but essentially helping them get to a place where they’re ready to raise or maybe some founders may decide, actually, it’s not what I want to do, because I’ve done that the customer validation work, and this is not the right time, not the right idea. Maybe not do it, whatever the case might be, I think that we believe, you know, maybe the future precede. Yeah,
yeah, I heard some talking about Inception, investing, and finding founders that are thinking about certain companies, or fit the profile of those that might start companies and help them think through that that process of ID doing customer discovery, arriving at something that they want to spend the next decade of their life on. It’s interesting to see that not proliferate, I know contraries, doing something, perhaps adjacent or similar, it makes a lot of sense, like going earlier. And earlier. From your perspective, I wanted to circle back to competition and specifically price, is pricing as high as you’ve ever seen it at this stage? Or where would you assess that we’re at on the spectrum of valuations,
it’s certainly a big, you know, a lot more reasonable than it was two years ago. And I think more than price, what’s changed recently is, you know, we actually get time through diligence, which is nice. There’s not four term sheets that every every company you want to invest in. So there’s not as much heat right around everything, which is actually really good for both parties, the founders and the investors, because again, this is a very big decision. So you know, who you partner with, that you cannot fire your, you know, Cap table, investors that you want to take the time to find the best partners, the prices, I’d say there’s a tale of two cities, I think, if you’ve got an you know, very strong resume coming out of, you know, one of the foundational model companies or something, you know, Bullseye AI, and you’re doing something in AI, it’s expensive, right, it’s it the the rounds are larger in size, also, in those cases. So the delusion, you know, what we’ve noticed in a lot of our data over the last, you know, eight years or so, is found or celebrate 20% plus minus at this, you know, the first round, that is still the case, it’s just that these rounds might be a little bit larger. And that’s why we have a larger font that we can scale up to, you know, write a large check and still participate in those rounds and get our, you know, desired ownership. But I’d say if it’s more of an it’s crazy, I’m saying this, but like a traditional industry, that’s like not AI is doing something in digital health, or millions of places where there’s opportunity, logistics, climate, the prices are a lot more reasonable, right? It’s not, not we’re not, and we’re not bargain shopping, to be honest, that there’s certainly you know, you can find very good prices, we tend to again, focus on what we believe are really strong builders, product, product centric engineers, so on and so forth. So prices are still high. But for us, you know, we tend to focus on price, we tend to focus on like ownership more than we focus on price. So we think it’s fine. But
how is your relationship with price evolved over time, actually price and round size? Because I’ve, I’d like to get your thoughts on round size in a minute. But how is your relationship with round size and price evolved over the past decade? Plus,
you know, what I’ve learned in venture over time are three things matter. And in that order, number one, you’ve got to be the best companies, it is a power law business, there is no way to get around it. If you’re not in the in the companies that are the outliers, there is no way to make the venture math work. Because inevitably, there’s gonna be a lot of losers and and hence you need to be in the power law companies. Number one, number two, ownership matters, right? So not only do you need to be in the best companies, you need to own as much as you can have these companies or at least own enough commensurate to the fund size. And number three tends to be the entry valuation. And of course, you want that to be as low as possible, but not at the cost of the other two higher order bits, right? So yes, you can get into, you know, low price deals, but if they’re not the best companies, or you don’t have high ownership, venture math does not work. Right. So that’s sort of how we, you know, look at companies and hence we’ve been and this will be as the as the market has evolved and round sizes have gotten larger. We’ve raised larger fund, right commencer. Today, as we’ve said, look, we’ve got to be the best companies and we’ve got to own a meaningful portion, and our ownership has to go up, right? If our font size is gonna go up, but the entry valuation, we don’t also, we don’t really control that much, right? Because if the market is willing to pay a certain price for the best companies, well, guess what, I got it, I’ve got to match that. And in many cases, we’ve been 10, or 20%, lower than the lowest offer, and the founders are still chosen to partner with us, which is very humbling, we’re not going to get into a deal of 50% of the work, right? That’s just, I would judge a founder if they picked us, right. So the most savvy founders do have a pretty good sense of what their company’s worth at this stage, we’re investing and we have to be that ballpark, and we’ve gotten ourselves comfortable because again, it is a it is a parallel business. And if that’s what it takes to be the best companies and get the desired ownership, we’ll go for it.
Do you think too much capital at the earliest stages can kill companies, like leading around that $4 million precede rather than two?
Oh, absolutely, it is, you’re adding more risk to the company. Right? I don’t think founders realized that I mean, no matter how much money you raise, founders always have 18 months of runway. So and the challenge with that is several fold. Number one, what it means is your burn is going to be higher burn is higher means you probably have hired more people. Right? What that means is you’re probably working on too many things for that stage, right? You’re going in too many directions, or you’re building very fast, which, ironically, can be a bad thing, right? Because you’re not able to be nimble on running experiments. And as I was talking about learning, your piece of learning actually goes down, right? Because you tend to build the product way more way more before you put in front of the customer. And that’s just like not good for business. Number two is you have a larger team management overhead, right? The founder suddenly find themselves running a company versus running a set of experiments, right? Very bad for business, right? at early stage, the the expectations go up, right? Because if you’ve raised your last run of 10 million post money versus 30, well, that’s a very different company, when you go out to raise the next round, right on what the expectation will be on what the next round price needs to be, what you should have accomplished, so on and so forth. So in so many ways it is and look, life is not binary. So I’m not going to say just because you raised a big round or a high price, you are absolutely done for No, that’s not the case, it just adds more risk, right? It’s one more thing you have to fight against. And in a world where odds are already stacked against you, when you start a company. It’s one more thing, right? Well, you’ve made your odds worse, not zero, you’ve made it worse, versus companies that raise what we believe is more of a right sized round, you know, one and a half to two and a half million dollars and say, Okay, I’m going to be very disciplined constraints are great at this stage, I’m going to run a set of experiments, stay nimble, learn rapidly. And when I feel that I have early sense of product market fit, that’s when I raise more capital, and we accelerate, right, but I want to give myself the leeway to say, we don’t know what we’re doing yet, right? We’re gonna go figure that out. And I’m pricing my company accordingly. I’m raising money important. Yeah. How
do you reconcile that, with deals of that get competitive, and maybe that one and a half $2 million round balloons to 3 million 4 million at times, or you could put in an additional 500,000? Whatever it might end up being to get additional ownership in a company you really like. But it to your point, it increases the risk?
Yeah, look, it’s case by case I wish I could give you a blanket answer, I think we’ve tried to understand the motivations of the founders, right, and why they’re doing that. I think in some cases, generally, it may be a little bit more capital intensive, especially in the AI world, if you’ve got to buy a bunch of computer stuff. Sometimes the founders a lot more mature, right, maybe it’s a second time founder, they understand some of the perils that I just alluded to, because they’ve lived that firsthand. And they are we are more confident than being fiduciaries of that of that capital. But it’s case by case. But there’s also many companies where we have stood down and said, Look, this is what we would love to invest, but not at this price or not, you know, when the round size, this size, just because we believe that that risk, and it is a subjective call we make but that risk has gone past a line where we don’t believe you know, we’re either gonna get compensated for the risk we’re taking, or this is put too much risk on the company. And we believe that is going to, you know, shortchange their their future. And you know, we’ll keep looking right in that space, maybe something else comes up in the future. And you know, we’re pretty sensitive to conflict. So if we make a call and invest in one company that obviously gets conflicts us out of everything else. So in some cases, it may make sense to just sort of, you know, stand down. Yeah.
And to wrap up if we could feature anyone on the show, who should we interview on what topic would you like to hear them speak about?
VC or founder?
Either one doesn’t or could be neither. But
I think one of the smartest people I’ve ever I come across in the venture ecosystem is navall Ravi Kant, but I think a lot of people know that Saturn entered if you hadn’t already, but he’s he is just everything, every wisdom he drops is just incredible. And my former colleague, Eric Paley, at Founder Collective, one of the smartest people in venture I’ve had been lucky enough to work with, I think he’s got an incredible amount of wisdom, we’ve had him at some of our core events. Those are probably the two names I
know, both are great. Do you have any habits, tactics or techniques that you would consider a secret weapon for you or for?
I’d say one of the things that really stands out, it just it’s more of a mindset, which is, we always try to empathize with the founders going through and their, you know, their fundraising journey, partially because we have to do that every couple of years. So what that means is, you know, get back really quickly, right? Always get back, right never goes to the founder, right, which I know sounds like a little bit table stakes. But it’s amazing how many founders we talked to are like, never heard back from an investor. But also when we get excited, we move very, very fast, we drop everything else, the entire team kind of goes all hands on deck, trying to get smart on the opportunity really fast. And that really messes with founders, because they’re like, Wow, we move fast. It’s nice to see VCs also move fast, be hyper efficient with their time, we tend to do intro calls actually, pretty short, sometimes 20 minutes, right, not even 30 minutes, we tried to send materials at a time so they can read about our fund. So we can be very efficient with their time when we had them alive. A lot of small things that I think add up, right, and it’s really that customers customer experience that we can give to founders that is respectful of the fact that the time is their most precious resources like it is ours. And we want to be we want to be judicious about it. Yeah.
And then last Goro what’s the best way for listeners to connect with you in the firm?
Yeah, look, if you’re if you’re a founder, we’re pretty reachable just by first name@afford.vc A follow me on Twitter at GJ our at a for Lisi, you know, if you’re a founder just getting started, we want to hear from you. So please, please just mentioned in the subject line that you heard about your podcast here, and I’ll be I’ll be sure to at least read the email and we’ll try our best to respond as well.
Awesome. All right, man. Well, thanks again for doing this. I appreciate you coming on.
Thank you. This is fun.
All right, that’ll wrap up today’s interview. If you enjoyed the episode or a previous one, let the guests know about it. Share your thoughts on social or shoot them an email, let them know what particularly resonated with you. I can’t tell you how much I appreciate that some of the smartest folks in venture are willing to take the time and share their insights with us. If you feel the same accomplishment goes a long way. Okay, that’s a wrap for today. Until next time, remember to over prepare, choose carefully and invest confidently thanks so much for listening