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1/25: We’re witnessing one of the most exciting periods in VC history. Funding is flowing freely, valuations are stratospheric and gigantic exits have become the norm. As a VC this should feel great, but does it? Maybe not. What follows is a rant that bears my soul on the topic:
2/25: Many Investors have offered their insights on this topic, most of whom provide clever narratives that justify what’s unfolding in front of us. I felt that given the huge amount of speculation running rampant I’d share my inner dialogue rather than a buttoned-up perspective.
3/25: My inner dialogue starts with shock, awe and distrust. For those who are new to investing, it’s important to understand that what’s happening in the private and public markets is truly amazing. This isn’t a normal environment and it can’t be easily explained.
4/25: It’s also important to understand that almost every VC who has insight into the market dynamics is a public figure who by definition benefits from what’s happening. This has caused me to be on high alert when it comes to believing the hype.
5/25: Behavior is shaped by incentives. Nobody will say anything that could negatively affect the outcomes within their own portfolio. VCs will complain about the price of new investments, but they’ll be the first to justify the value of their existing portfolio companies.
6/25: This is the nature of the game. It’s the elephant in the room. The ultimate result is that there are two camps that have emerged in the VC community: Those who completely believe in and are embracing the new world and those who are struggling to get there.
7/25: To understand the philosophy of these factions, you have to start by internalizing that there’s always been two competing investment frameworks. We can call them East Coast vs. West Coast or Fundamentalist vs. Revolutionary. Choose your own lexicon.
8/25: Fundamentalists believe that what’s possible is dictated by the dynamics of an ecosystem. Building in stages on top of solid unit economics is what matters. To Fundamentalists, the journey matters because great companies are built on top of good companies.
9/25: Revolutionaries believe that what’s possible is a function of differentiation. Dominance of a big market is the only goal. To Revolutionaries, only the destination matters because success is a function of an amazing team eventually dominating an ecosystem with large TAM.
10/25: Fundamentalists believe that financials matter because a company’s enterprise value will eventually collapse to a function of margin, volatility, profit and growth. Revolutionaries believe that dominance is the goal and financials will follow.
11/25: For any business, valuation is a function of the intrinsic value of the current business plus the option value of what it can build in the future. Fundamentalists and Revolutionaries weigh the components of valuations vastly differently.
12/25: But even with these differences, over the long run the best investors have historically delivered great returns regardless of their philosophy. Great investors spot great opportunities. It was easy to root yourself in whichever philosophy you preferred because both worked.
13/25: To those who know me, it won’t surprise you that I label myself a Fundamentalist. I always have been and I thought I was always going to be in this camp. But what’s creating a personal sense of angst is that today’s market is clearly rewarding Revolutionary thinking.
14/25: Many Revolutionary Investors are cheering loudly in an “I told you so” manner that’s quite annoying to Fundamentalists. To them the current market represents their hierarchy taking back control of how VC investing “should” work.
15/25: And there are many recently IPOed/SPACed companies that make my head hurt. “The market is paying how much for that?” is my morning mantra. “Look at their lousy margins. Look at their overhead. Does their model even work?” is my bedtime prayer.
16/25: In response to my existential crisis, some of my closest confidants in the Revolutionary camp point to growth and scale as the missing forces that unify both worlds. Given enough growth and enough scale, the valuation math behind a company’s enterprise value works out.
17/25: If I’m honest, I’ve found myself in recent days routing for the collapse of the high growth, highly valued companies with lousy financials. There’s something inside of me that deeply needs this to happen. It would be proof that the path of the righteous is the path I’m on.
18/25: It’s impossible to watch a boxing match and agnostically hope that it’s a good, clean fight without becoming attached to a fighter along the way. Someone in the ring becomes “your guy” (or girl). And if this doesn’t happen then you aren’t watching closely enough.
19/25: I used to believe that it was just a matter of time and that the markets would vindicate my views. But as the scale of the VC asset class has grown and the impact of the differences in philosophy are diverging, I’ve realized that I can’t stand firm and preach anymore.
20/25: The courage to back companies that only work with massive scale and market dominant positions requires religious conviction. The “all or nothing” path to building dominant companies requires conditional probabilities all falling into place. Parlay investing is tough.
21/25: But where the Revolutionary Investors have an edge is that today’s market is allowing them to sell downstream risk to public investors. It doesn’t matter if the third bet in their Trifecta thesis loses. They’ve already sold their card for a premium after two winning bets.
22/25: Philosophically I hate the fact that in this market Investors can profit from selling half-baked companies at fully-baked prices. But I don’t write the rules. And there are narratives that have been constructed that justify that today’s market is actually rational.
23/25: And the dreamer in me has mad respect for Investors that back and Entrepreneurs that create dominant companies. I’ve done it a number of times and it feels great when all the pieces come together perfectly.
24/25: The path to greatness might look reckless and irrational or it might look organized and thoughtful but the truth is that the only thing that matters is actually getting there. Outcomes pay the bills. Journeys are what stories are written about.
25/25: So what does it mean for me? I’m not sure. I so much want the market to reward the world view that I’ve become attached to but I’m opening up to the possibility that the one who needs to adjust is me….kind of…sort of…but maybe not.
