Best of LinkedIn: Venture Capital CW 41/ 42

00:00:00: Provided by Thomas Allgaier and Freeness, based on the most relevant linked-in posts about venture capital in calendar weeks forty one and forty two.

00:00:08: Freenest supports general partners in identifying relevant limited partners across multiple sources researching connection strategies coordinating event attendance And running structured outreach campaigns that turn cold lists into scheduled conversations and committed capital.

00:00:22: You can find more info of description.

00:00:25: Imagine

00:00:26: writing a check to an early stage startup Watching it hit a billion dollar valuation in the press and then well, realizing your shares are essentially worthless.

00:00:36: Yeah just because of how the round was structured

00:00:38: exactly.

00:00:39: so today we're tearing down all those vanity metrics.

00:00:42: We want to give you a no fluff highly focused deep dive into the top venture capital trends circulating across LinkedIn right now

00:00:49: especially tailored for You The strategy M&A and investments professional.

00:00:54: We're looking at the actual mechanics of the venture market, where the massive pools of capital are trapped.

00:01:00: How headline valuations are being weaponized against early investors and really fascinating ways emerging managers or fighting back

00:01:08: using like raw mathematics in AI to outmaneuver the legacy giants.

00:01:12: so our mission here is really just cut through the noise.

00:01:15: we want to understand what capitals actually flowing look.

00:01:18: a hidden reality event returns

00:01:20: right starting right up top funnel Just looking at how much money is in the system and exactly whose hands it's sitting.

00:01:27: Yeah, And attention there as wild because on one hand John Callahan pointed out that AI Is creating this historic innovation boom?

00:01:34: Oh absolutely.

00:01:35: but on the other hand The VC ecosystem is Behaving with a completely paranoid scarcity driven mindset right now.

00:01:42: yeah, and you really see That scarcity of mindsets materialize when You look At who actually holds all the leverage.

00:01:48: Right.

00:01:48: I mean nick polos shared some wild data showing that through the third quarter US venture capital funds raised a hundred and eight point five billion dollars.

00:01:57: That's a massive number

00:01:59: it is.

00:01:59: but wait, funds of five hundred million or more they absorbed as staggering seventy-eight point one percent of that total.

00:02:07: Wow

00:02:08: yeah to put that in perspective A sixteen Z alone closed twenty three point eight billion dollars.

00:02:14: Wait really?

00:02:16: One firm!

00:02:18: all US venture capital raised this year.

00:02:20: See, a fifth of the entire market going to one logo that fundamentally warps how capitals deployed completely.

00:02:27: I mean it's like trying to steer a super tanker through an arrow canal at a twenty billion dollar fund size.

00:02:33: can these firms even operate on a traditional venture model?

00:02:36: Not really no.

00:02:37: or are they just you know forced to blindly deploy massive checks to justify their existence because A two million dollar seed check doesn't move the needle in a twenty-billion dollar pool.

00:02:46: Right, the legal overhead alone makes that totally inefficient.

00:02:50: They are structurally trapped by their own scale and Olivia O'Sullivan's data really reinforces how skewed this has become.

00:02:57: mega funds make up just six percent of The actual funds out there

00:03:01: but they're taking all the money

00:03:02: exactly There absorbing seventy eight percent of LP capital.

00:03:05: so the middle-and lower tiers of the market Are literally starving

00:03:09: right?

00:03:09: And didn't a total number of active firms completely drop off?

00:03:13: Oh, massively.

00:03:14: We went from nine hundred and twenty-seven firms closing at least one fund in twenty-twenty two down to a mere two hundred and eleven so far this year.

00:03:22: That is brutal.

00:03:23: So these mega funds are acting like uh...like massive gravitational black holes just pulling into all the institutional money

00:03:30: Precisely.

00:03:31: And Scott Stanford noted that In the first half of twenty twenty six Just three firms took forty eight percent Of all capital raised.

00:03:38: Three firms

00:03:39: Yeah.

00:03:39: And the top ten deals drew a record sixty-eight percent of deal dollars.

00:03:43: Okay, but here's my fundamental pushback on that.

00:03:46: if institutional LPs you know The Endowments the pension funds If they know that smaller funds historically produce better multiples Why are they just blindly writing hundred million dollar checks to these mega funds?

00:03:57: Well it comes down to institutional constraints.

00:03:59: right and uh...the perception of safety.

00:04:01: Like nobody gets fired for buying IBM.

00:04:03: Exactly A massive pension fund needs to deploy a billion dollars this quarter.

00:04:08: They do not have the internal analyst bandwidth to underwrite fifty different twenty million dollar micro funds.

00:04:13: But that would be a nightmare to manage?

00:04:14: It is, it's just bureaucratically easier to write three-three hundred thirty million dollar checks to establish mega brands.

00:04:21: tell their investment committee they backed at the consensus leaders and move on.

00:04:25: Okay but the downstream effect of that Is what we really need to scrutinize.

00:04:30: With all this capital concentrated at the top.

00:04:32: The natural next question for you listening Is that money actually coming back to the LPs?

00:04:38: Right.

00:04:39: Going from capital raised, to capital that is definitely not being returned

00:04:44: Because there's a severe disconnect between paper valuations and actual cash distributions right now.

00:04:51: Oh huge.

00:04:52: And the metric we have to talk about here is DPI distributed to paid-in capital.

00:04:57: Ryan Baird pointed out this really wild paradox defining the market.

00:05:01: over the past year venture ranks as The top performing private asset class at nineteen point.

00:05:07: one percent on paper,

00:05:09: On paper being?

00:05:11: Exactly because actual cash distributions are sitting near all time lows.

00:05:16: It's sobering.

00:05:18: I mean a two thousand seventeen Vintage fund is now nine years old right?

00:05:22: yep

00:05:23: after nearly a decade The median fund from that year has returned just thirty seven cents in cash for every dollar invested.

00:05:31: It's wild.

00:05:32: and the two thousand nineteen funds,

00:05:34: Just

00:05:35: four cents on a dollar.

00:05:37: LPs are effectively paying management fees on trapped capital Year after year.

00:05:42: And Chris Harvey insight makes those older ventures look almost generous by comparison.

00:05:47: Oh

00:05:47: really?

00:05:48: Yeah, for the twenty-twenty one to twenty twenty four vintages.

00:05:51: The median DPI is literally zero point zero zero X zero cash returned

00:05:57: Wow absolutely nothing

00:05:59: Nothing.

00:06:00: so LPs are now actively passing on GPs who have top decile paper marks because you know You can't pay out pension obligations with theoretical markups

00:06:08: right?

00:06:09: LPs need liquidity to fund their next capital calls and the well is just dry.

00:06:14: Olivia O'Sullivan pointed out that net cash flow to LPs has run negative by two hundred and two billion dollars since twenty-twenty, too.

00:06:21: That's a massive hole

00:06:22: it is.

00:06:23: And there's this enormous queue of nine hundred forty five unicorns holding over five point seven trillion dollars in largely unrealized value.

00:06:31: And that value is trapped because the exit environment has completely deteriorated.

00:06:36: right nobody is buying

00:06:38: exactly.

00:06:39: Jason M. Lemkin brought up some great data on this, private equity fundraising fell twenty-nine percent overall and middle market PE plummeted by forty three percent

00:06:48: which is a huge deal because PE firms are traditionally the buyers for these maturing B to B SaaS companies right?

00:06:54: Exactly when you thin out that pool of midmarket buyers there's nowhere for these companies to go.

00:07:00: it reminds me if the analogy Scott Sanford used in The Sources It's like packing way too many people into a nightclub with way to few exits.

00:07:07: That is exactly what it feels like!

00:07:09: But I mean, if Marks aren't returns and LPs are just paying fees on trapped capital how much longer before the paper wealth illusion completely shatters?

00:07:18: Well pressure already showing in the cap table because exits are stalled and cash is tight The deals themselves becoming incredibly complex

00:07:27: And sometimes outright hostile of early investors.

00:07:29: Exactly

00:07:31: Before we dig into the financial engineering happening behind-the-scenes of these makearounds, I just want to casually drop a quick reminder for you tuning in.

00:07:39: If you're enjoying this deep dive take a second to subscribe so you don't miss our future additions.

00:07:44: Definitely do that!

00:07:45: So let's look at the reality behind these celebratory press releases... Yeah pull

00:07:49: back The Curtain.

00:07:51: Malata Alakazai provided a really detailed breakdown.

00:07:54: When a company announces the massive mega round today, it is rarely clean equity investment anymore.

00:08:01: Often they're just bundled package of like eighteen months rolling safes and bridge notes.

00:08:06: And safe as supposed to be simple bridge right?

00:08:09: But when you stack them up over eighty-months with all different caps and discounts its a mess!

00:08:14: It's complete mess...and Alucozai detailed this specific tactic.

00:08:18: he calls The Two Tiered Valuation Squeeze.

00:08:21: This is work.

00:08:22: It's crazy.

00:08:23: let's explain how this squeeze works.

00:08:25: say a lead VC wants fifty percent ownership, right?

00:08:28: Right but the startup founders are desperate to announce A one billion dollar headline valuation.

00:08:33: so they look good to the press.

00:08:35: So what they do Is They Tronch The Round.

00:08:37: yeah

00:08:38: like ten million dollars comes in at a heavily discounted hundred million dollar valuation

00:08:43: Exactly and then the remaining fifty million Comes In At That inflated One Billion Dollar Valuation.

00:08:49: So the total capital is sixty million dollars, but The Lead VC's effective entry price their blended average.

00:08:56: It's just four hundred million dollars

00:08:58: Right.

00:08:58: so the lead gets their ownership at a massive discount.

00:09:01: But the fallout Is what's really brutal?

00:09:03: yeah

00:09:04: because the day after it closes?

00:09:05: The lead VC instantly marks up there early tranche for their LPs

00:09:09: showing A huge gain.

00:09:10: right

00:09:11: but the Early Angel investors They get a pro rata notice demanding they pay the artificially inflated one billion dollar headline price if they want to defend their ownership.

00:09:21: Which, they can't afford to do!

00:09:23: The effectively gets squeezed completely off of the cap table.

00:09:26: It's literally just Hollywood accounting applied to venture capital.

00:09:30: That is such great way.

00:09:31: put it.

00:09:32: We're movie grosses of billions but studio uses complex shell structures so looks like net loss on paper and don't have to pay actors profit points.

00:09:41: Exactly The headline valuations are just marketing tools, but they're being used as weapons against early believers.

00:09:48: So if you're a strategy or M&A professional how do you even evaluate the true health of a target company's cap table?

00:09:55: If

00:09:58: You really have to dig into the actual legal documents.

00:10:01: The preference tax, all of it because the desperation out there is real.

00:10:05: Yeah.

00:10:05: Nicole DiTomasso highlighted just how desperate investors are for AI access right now.

00:10:10: Oh with the SBVs?

00:10:11: Yeah!

00:10:11: Investors using layered special purpose vehicles.

00:10:14: Just get in companies like OpenAI and Anthropic

00:10:17: And they're paying crazy middleman fees up

00:10:20: to eighteen percent.

00:10:22: Wait... Eighteen percent?

00:10:24: Yes

00:10:25: Sometimes paying eighteen percent just for the privilege of getting on the cap table.

00:10:29: That's

00:10:29: unbelievable!

00:10:30: So while the mega funds are playing this highly engineered super capital intensive game at the top, what is happening with the emerging managers?

00:10:38: Well, that's the interesting part.

00:10:40: We finally get to look at how the smaller emerging managers are adapting to survive

00:10:45: using math and artificial intelligence

00:10:47: exactly.

00:10:48: Kevin Dowd via Aaron Dubin reported That The smallest VC funds historically produced some of the absolute best returns in the asset class

00:10:56: But they're the ones struggling the most to raise capital right now because LPs Are running To the mega funds for safety

00:11:01: yep.

00:11:02: so They have to be smarter.

00:11:04: And Mackey Leventis shared this really fascinating portfolio construction math that these smaller funds are using.

00:11:10: Right, This is where it challenges standard statistical intuition.

00:11:14: adding more portfolio companies doesn't raise your average return

00:11:17: does?

00:11:18: no It raises you're median return.

00:11:20: right.

00:11:20: and that distinction as everything.

00:11:22: He showed that the median fund return rises from one point five seven X at ten companies, all the way up to one point nine two x. At forty companies.

00:11:32: because venture capital operates on a power law distribution most startups fail.

00:11:37: so if you only make ten vets You're probably going to miss The One Outlier That Returns the Fund

00:11:42: Exactly.

00:11:42: So this strategy here is that forty to sixty companies Is the sweet spot.

00:11:47: It covers the inevitable losses, but still leaves room for that massive upside.

00:12:12: Yeah, John Gannon shared that incredible story about Yohei Nakajima.

00:12:16: Oh the firm OS?

00:12:17: Yes!

00:12:18: He literally built a custom FirmOS from the driver seat of an RV during a two-week road trip

00:12:24: using Starlink and AI Agents.

00:12:26: It's

00:12:26: wild it's

00:12:27: wild

00:12:27: yeah.

00:12:28: And Adeo Resi shared his staggering example with us too.

00:12:31: he noted that AI agents migrated three whole VC funds over Two hundred ten LPs in six thousand documents In just one single weekend.

00:12:40: That is insane.

00:12:41: That kind of migration historically took, what?

00:12:43: Three months of manual labor.

00:12:45: At least three months yeah.

00:12:46: and Scarlett Pierce at Delta V gave another great example.

00:12:49: she talked about cutting their quarterly reporting process from a full week across twenty eight different spreadsheets down to single AI

00:12:56: prompt.

00:12:56: just the single prompt wow.

00:12:59: but

00:13:00: let me ask you this then if I can do three months back office fund operations in a single weekend Does the traditional mega fund advantage of having a massive support staff suddenly just evaporate?

00:13:13: It really starts to look like a bloated liability.

00:13:16: Yeah, right

00:13:17: is AI essentially The great equalizer for emerging managers?

00:13:21: I think it levels the operational playing field absolutely But it does leave us with one final pretty provocative thought to mull over regarding the whole ecosystem.

00:13:30: what's

00:13:31: that?

00:13:31: well consider What happens when this current wave of AI infrastructure investments finally needs to prove its commercial viability to enterprise buyers.

00:13:40: Because right now, the market is basically relying on just three massive AI companies to unlock what?

00:13:46: Two trillion dollars in fund value

00:13:48: exactly trillions of dollars and paper wealth as riding on these few mega IPOs.

00:13:53: What systemic risk does that pose to the entire venture ecosystem if Just one of those IPOs underperforms or gets delayed?

00:14:00: That Is a terrifying single point Of failure for The whole asset class.

00:14:04: It really is.

00:14:05: If you enjoyed this episode, new episodes drop every two weeks!

00:14:08: Also check out our other editions on PE Fundraising, PE Exit Strategies, PE Value Creation, Strategy & Consulting and M&A.

00:14:17: Thanks so much for joining us in this deep dive And definitely don't forget to subscribe So that we can catch the next breakdown.

00:14:23: See ya next time.