Very True by Verissimo

Alex Oppenheimer (00:00)
Welcome back to another solo episode of Very True. Today we're going to talk about something I've been writing and thinking about for 10 years and that I think has gotten more distorted, not less, in the last few years. It's about how venture math actually works and specifically how it works differently depending on what kind of fund you are, what stage you're investing at, and what kind of company you're building. This sounds like a finance episode.

It kind of is, but it's really about one question that I want every founder and every early stage investor to walk away asking themselves. The question is: are you running your own option bet or are you somebody else's? Because the difference between these two things is the difference between generational wealth and walking away from a successful exit with nothing. Let's get into it.

Alex Oppenheimer (01:34)
I sent a message to a friend just today.

It was three lines. I want to read them to you, and then I want to spend the next half hour telling you why I sent them.

Right now, it's either these $50 to $250 million exits, zeros, or to the moon. And the moon is unlikely to actually happen. And the more money you raise, the worse off you are when you do almost inevitably sell for one of these $50 to $250 million deals. Let's sit with that and also realize that starting a company from scratch and selling it for between $50 and $250 million.

Within a few years is extremely impressive and extremely difficult. I'm not talking about the dogs that we all have in our portfolios or that we've all seen. I'm talking about great companies. I'm talking about companies that grow from zero, from nothing, from an idea to tens of millions of revenue, real revenue, real customers, real technology.

And I'm seeing this on the ground, both firsthand, secondhand, and in the news. And while every founder starts with their rocket ship pointed towards the moon, it's become far too easy to forget that most ships will never make it all the way to the moon. Even if the journey looks so, so promising, the reality is that most individuals who find success do it somewhere along the way. Preserving and optimizing that middle path.

is actually the best way to create generational wealth. And that's really why we're all here, right?

I've told this to people before who complain about the intensity of this business or that business. And I say, look, you could go be a government employee. You can be a mailman. There's nothing wrong with that. But if you want to create eight figure and nine figure wealth for you and your family, this is the reality that we live with. And I think that it used to be that rich was rich. I've

Think there's a chasm that's being created between that eight to nine figure wealth range, which is an obscene amount of money. And again, it's generational wealth. There's another term for it, which I'm not going to use here. And those multi-billion dollar outcomes, which if you ask me, I'm not interested in. I personally, I think it's a burden. I think you're too much in the news. I don't think it's good for raising kids, and a whole bunch of other issues. So I'll start with a little bit of a

Confession, which I alluded to earlier, which is that I've been writing about this for 10 years. one of my first ever posts, was titled, You Pick the Valuation, I Set the Terms. And I talked about the dynamic between preferred equity investments, liquidation preferences, and this focus in the media on headline valuation numbers. The truth is, when the media reports a valuation number, we don't know what's behind it. We don't know the terms.

We don't know what the founders had to give up for that. And savvy investors are happy to give up that headline valuation to get coverage and control on whatever they're investing for. When I wrote that piece 10 years ago, what they were investing for was locked in terms. And so what you found more and more was maybe there were 2X liquidation preferences, meaning that nobody makes a dime besides the last big investor until they get 2x their money.

And if they're a big investor in a late stage fund and locking in 2x, they say, hey, we can't lose. Now, if you've been in the market, you know that these things kind of became unacceptable. They are non-competitive. But a really important thing also changed, which is the entire market dynamic in venture and how it's absolutely exploded in the volume of capital. This has made a big, big impact. And so while people used to be really interested in locking in a 2x.

gain and then obviously still maintaining lots of upside. People don't care about that anymore. What they care about is markups. There hasn't been a lot of liquidity. It's been unclear for a long time where that liquidity is going to come from. It does come. There are massive amounts of cash piles sitting in a handful of very, very large successful technology companies. And by the way, old school industrial non-technology companies that are now being forced to buy into those markets.

And that bodes well, but the numbers still don't work out well. In 2023, I actually wrote another piece called How to Mess Up a Good Company and Not Make Any Money Along the Way. Now, the difference between 2016 and 2023 was that in 2016, I was working at NEA. In 2023, I was two and a half years into running my own seed fund. And so

Where it went from a mathematical question, it turned into a very practical question about being a seed investor and being an early stage investor and the nuances of how that changes the advice that you give founders, your alignment with downstream investors, and everything in between. I'll link both of these pieces if people want to dive into the nitty-gritty numbers and details and calculations and charts that I show there. But

You'll see that A lot of it's gonna come out here in a more qualitative way.

There's been another big change since I wrote both of these pieces. And one of them was only three years ago, which is that the market continues to bifurcate. It continues to get more and more extreme. Again, 10 years ago, headline valuations were already a problem. Three years ago, they had actually almost started to peter out a little bit. And we saw our first taste of the 2020 and 2021 kind of hype rounds coming back down to earth and feeling that hard fall.

But it feels like everyone forgot, no one cared. it was five billion or bust. Now it's 20 billion or 100 billion or bust, or just nobody cares anymore. I see it on the ground with a lot of other investors, whether they're pre-seed seed, Series A investors, where they're like, I don't know what to do. I don't know if I'm gonna be able to get this thing financed by the next round of financing if it's not looking like it's one of these multi-billion dollar outcomes. One thing I always come back to, I've had a

Pre-seed investments, founders that I work closely with that are go out to raise a seed. And the feedback that they get from seed funds, we're talking about sub hundred million dollar funds, is that they don't see a path to this being a $10 billion company. Now, that's not your job. $10 billion outcomes for a seed fund, that's a sub hundred million dollar fund. That's just not your job. Now, that depends on two very important things. One is ownership, and two is entry valuation. Now, those two things.

assuming you're a sub hundred million dollar fund and you have some appropriate level diversification are tied to each other. But the math doesn't need to work that way.

So let's dive into that. The shape of venture outcomes used to be a curve. It's now collapsing into these three distinct buckets. And the middle one, which is where most founders actually live and really hope to live, is being squeezed and it's being squeezed hard, but not the way that you think it is. So the way that it used to work, where there was that there were lots of 50 to 500 million dollar outcomes of these excellent companies. There were a few bigger ones, and then there was some zeros.

And that was the distribution that resulted in great fund level returns, not mediocre ones, but great ones. The way that this typically worked is you would invest in a company at the early stage that you thought had a good realistic chance of being one of these nine figure outcomes, maybe 10 figures. And then the way that you made stupid, stupid money as an investor and as a founder, frankly, was that it became a 10 figure outcome.

An 11-figure outcome, a 12-figure outcome. But as soon as you start modeling for that on the front end and planning for that $1 billion to $10 billion outcome as your base case, the outsized returns necessarily disappear. So one of the reasons that this happened is that the markets flooded with capital because people made a lot of money, because those $100 billion outcomes happened. That then resulted in prices going up, which meant that.

more and more companies getting started, which meant that companies needed to raise more money just to compete with the other companies that were being started. And it became this very cyclical, self-serving, self-feeding thing. Hard to say that the LPs are winning from this. A handful obviously have. Hard to say that the founders are winning from this. Again, a handful obviously have.

GPs, honestly, have done pretty well. Let's be real. fees trade at a really high multiple. And when it when a series A goes from being an eight to twelve million dollar round to being a fifty to hundred million dollar round in a company at the same stage, which requires the same amount of diligence. And the only thing that's really changed is that market dynamic where you have to win and sell and compete on the deal, fees rule the day.

you can pay people a lot of money, you can pay yourself a lot of money and and and that matters.

So we'll talk about one very specific problem here, which is that when you do get a company that a seed fund says, hey, we actually think this could be a $10 billion company. Now, anything that appears that it can be a $10 billion company now, almost necessarily cannot be. I'll let that sink in for a second. And the reason for that is simply timing. Now you could argue with AI, timing's all compressed. Now maybe we have better sight lines.

I would argue it's just more confusing and it's easier to get your wires crossed because things move that much faster and therefore small angle approximation actually becomes harder, not easier.

But the the issue there is if it's obvious to a seed guy, it's even more obvious to an A guy a year later or six months later or three weeks later, whatever it may be. And these things get financed out the wazoo. And frankly, every venture investor should be honest with themselves. Pretty much everyone would rather invest in a clean slate than a recap. It's just easier, it's simpler, it's cleaner.

So if the rubber hasn't even met the road yet, you could say that's an easier investment to make. And so companies that have a million of revenue and 50 million of pipeline are raising money at billions and billions of dollars of valuations and they're raising hundreds of millions of dollars. The problem is that it takes that $300 million wealth creation opportunity off the table. Now, if you're one of those founders that's already made a bunch of money, great, fine. We're all on the same page.

But if you're not and you've gotten swept away into this world, you could find yourself in a really unfortunate position. So my advice to those founders who haven't made a lot of money yet and are raising hundreds of millions, sell secondary. And here is the argument that you can use with your investors when they push back and say, no, don't sell secondary, blah, blah, blah. There's all these bad stories. We want to maintain alignment. It's very simple.

You can ask that GP at that fund how much money they make every year and how much wealth they've created for their family. And then you can ask them what their goals are and their future wealth creation opportunities. And they'll probably tell you it's to make hundreds of millions of dollars, if not billions of dollars. And you can say, I want to play that game too. But right now, a single would be great for me because I still live in a rented apartment and drive a Toyota Camry. Not that there's anything wrong with that, but if you want to be playing the same game as someone who has

Three vacation homes and a professional driver and a subscription to NetJets, you got to get a little bit closer to that. And so taking $5 million off the table when your company is worth, a billion dollars on paper and your personal equity is worth $350 million. I don't think that's unreasonable. Anyone who says that it's unreasonable, I don't know. Good luck. Maybe, maybe ask that before you raise the round.

⁓ it can also be it's also great negotiating leverage for founders. Don't be afraid to ask for those things while you're negotiating if you're one of these super hot companies.

So now let's dig in a little bit on the seed investors perspective. We talked a lot about the founders, and we can talk more about the seed investor piece. Like I mentioned earlier, seed investors have always kind of been aligned with the founders. Like, hey, yeah, we have preferred equity, ⁓ but we're so far down the cap stack that we're really aligned with the founders. A lot of seed funds and pre seed funds, by the way, that's why they have no follow on policy.

I personally don't subscribe to that, but I understand those who do. They say, We're gonna dig in with you and help you raise money. We don't wanna have the signaling, whatever. All our money's gonna be made on our initial investment.

And that's fine. there's two ways that that breaks down. The first is when the entry valuation is very high. When the entry valuation is very high and less ownership is attained by those early stage investors.

Alex Oppenheimer (13:20)
the other way it breaks down is even when you got in clean. If the company raises too much money downstream, the same dynamic catches you anyway.

Alex Oppenheimer (13:29)
The split becomes much more real. And I'll walk through a scenario that's very real to illustrate that.

Basically, If you invest in a company at a $5 million valuation versus a $50 million valuation, there's a big, big difference in how this plays out. Now, again, if you say, we're just shooting for the moon, it's fine. But again, know that most moonshots don't make it to the moon.

Let's figure out how to get rich on the way to the moon because we've developed a business that's actually driving value and kind of remove ourselves from market sensitivity, multiple compression, macroeconomic volatility, geopolitical risk, and things like that. If you create a valuable business, you should generate wealth for yourself. Now, if you invest in a valuable business and you're the first investor or one of the first investors, you should also do well.

I think you should also do well. maybe that's just me. But if you participate in a round that's five at 50, versus let's say a million at five. Those are both first financing sort of rounds. Let me provide the scenario where that works pretty differently, which is the case that's fairly common. A company

is growing super fast. they raise

one of those seed rounds that we'll talk about, either a five or 50. Then the next round is at 50, let's say, in the in the first case, then they raise at 500. And we'll just, we'll just kind of pause it there. They raise, 60 million dollars at a $500 million valuation. Now the company gets acquired for $200 million.

If you were in that $5 million round versus that $50 million round, there's a huge difference in how this shakes out. That $60 million that came in at $500, it comes off the top of the $200. Now we're at $140. That $140 then gets distributed. So while that $50 million

Thought that they were sitting at like a 9x, you know, 450-ish pre to the next round. Now they're looking at less than a 3x. That's a big difference. That's a that's a write down. That's a company that you walked out in front of your LPs and said, hey, I've got this 9X, and now it's not, you didn't lose money and ultimately you will distribute, and that's fine. But you were showing something that was a 9X and now it's a 3X. More likely, it's probably going to be closer to.

A one and a half X in a scenario like that. Now, if you were at a five million dollar valuation, then You sit a lot closer to the founders and you own a much bigger chunk of that company. And the math works much better in your favor. And we can we can dig through the math in a bunch of other cases, but when these liq prefs hit,

They hit pretty hard if you overpaid for a round. That's the harsh reality. and even though it felt like that future round that was your write-up, it was great because it wasn't that dilutive to you as an early stage investor and to the founders, it could actually hurt you more. that's the short of it. Like it would have been better instead of raising 60 at 500, if you had raised 40.

At 200. Now, if you could get to the same number, it's fine, but because the company only sold for 200, you either have 160 of remaining capital to be come down the waterfall, or you only have 140. These aren't like the best, most illustrative numbers, but I hope that the idea is coming across.

Alex Oppenheimer (16:33)
so the five million dollar valuation round investor ends up actually doing pretty well with a strong multiple return. And the $50 million investor gets killed by the same outcome.

What's important to remember about that is

If the fifty million dollar

valuation round is not the first round, that's understandable. That's okay. Either way, you get stuck in the middle. If you're investing first and taking that risk, you want to make sure that the math and the upside represents the type of outcomes that you are actually meant to be underwriting.

Alex Oppenheimer (17:02)
In my piece that I wrote in 2023, you can see a lot more details on how this can shake out and why having a really cut and dry secondary strategy as an early stage fund is super, super important. there's a whole another framework around secondary strategies and how to think about removing the emotional aspect of these things, which are your babies and your children that you're proud of, let's say, ⁓ and being able to say, Hey, I actually need to take some money off the table here because.

I want to levelize my outcomes. And that brings up another point, which is the big difference between MOIC which is a number people love masking or rating around to go raise your future funds with, and DPI. Because when the rubber hits the road, when the cash actually hits the bank, then these numbers are very, very different. I just texted a friend who seed invested in a company. The company just got acquired for billions of dollars. I think it's been.

eight or nine years since he first invested, it's gonna like five or six X his entire fund just on that one deal. And there's other good companies in that fund and that have already exited in that fund. It's doing amazing. And I texted him, Congrats, you know, on on this exit. And he goes, it still needs to get through it still needs to get through approvals. Now that's someone who understands that DPI is when the money hits the bank.

Even at that moment, the definitive agreements are signed, the the announcements been made. He's like, I'm gonna wait for the cash to hit the bank. And that's the right attitude. Now, in venture, that doesn't happen very often. So what do you hang on to? And the answer is you gotta live in both. You have to understand how has the value of this business on a fundamental level actually grown.

So I had an interesting conversation with a super smart friend of mine who is not a professional investor. He's an operator. He's done very well as an angel investor. And I had said something along the lines of like, you don't need these five billion dollar outcomes. Like, why are all these seed investors trying to underwrite to five to $10 billion outcomes at seed? I just find it's impossible and irrelevant. And he's like, Yeah, that sounds fine, but

I don't believe that that you can return that way. How do you return a fund that way? And I was like, dude, I I I sent him my fund model. I was like, here is how you do it. If you get one company that's worth a billion, billion and a half, then like you're golden. You hit all your numbers, everyone makes a lot of money. Your IRRs are great. Fine. So what's what's going on there? What's he missing? And the answer is that it's a multiples business. Now

If you're a sovereign wealth fund, it's not a multiples business, it's an absolute dollars business. But if you're a sub hundred million dollar seed fund or A fund it is a multiples business. And whether you invest 100K at a million dollar valuation, which I know sounds ridiculous, but that used to be what a seed round was, or you invest 10 million at a $100 million valuation, a multiple is a multiple. And in one case,

you have to build a billion dollar company, which is really hard. Ask someone who's done it, a real billion dollar company that's exited and gotten liquidity, versus in the other case, you literally need a $10 million exit and you 10X. it's the same. So if you're the type that's gonna write a, you know, a hundred K check, you might say, a hundred K though, versus ten million, like that's a lot more volume of capital.

Let's bring that down to a better example, which is a $1 million and a $10 million valuation. Then you have to generate a $100 million exit. That now starts to sound doable. For each fund size, these things matter. And this is something that founders, need to be sensitive to, which is how much do you matter to the fund that is investing in your company?

I invested in a friend's company and it was a party round initial round. And I actually wrote, I think, a slightly smaller check than some of the other funds that came in. But one of the funds is a $100 million fund, one is an $80 million fund, and one is like a $500 million fund. And the fund that he's in of mine is a $26 million fund. And so what I explained to him is you matter more to me than you matter to any of these other.

Funds. And he sat there and thought about it for a second and was like, okay, I appreciate that. You're right. And that matters. Economics drive the day, right? Like this is a money making business. Even though it's a lot of hype and a lot of sales and a lot of personalities and a lot of pride and a lot of media, this is investing. It's about making money. Let's not dress it up as anything else. And let's go in eyes wide open to what that actually means.

Going back to this example of like how do you return a seed fund without a multi-billion dollar exit? got to remember it's a seed fund. If you're a multi-stage fund and you're competing for deals and prices are being driven through the roof and you're a billion-dollar fund, then yeah, you need to own 20% of a $5 billion exit to return your fund on that deal. Simple math. So there's a couple of solutions. One, don't get greedy with your billion-dollar fund.

And have to compete with all the other billion dollar funds. or two, realize that getting rich on fees might not really be worth it. It's always worth it. Just ask any GP. If you really, if you get them drunk and you ask them, it's always worth it just to get rich on fees. That's ⁓ that's that's always the answer. Where you run into issues again is as an early stage investor who's not running that model, and this is why you need to have.

a secondary strategy the same way founders need to have a secondary strategy so that you can maintain that alignment. If you want to take a flyer, if you want to play for that $10 billion outcome, go for it, but go in eyes wide open, understanding what it's going to take to make that happen.

I'll wrap this up with one of my favorite lines, which is that sustainable revenue growth is the only thing that sets you free. Emphasis on sustainable. What does that mean? Sustainable means that you have the ability to survive and continue to grow, or survive, not grow, and be profitable. As I've always said, it's the same muscles that you need to grow as efficiently and as quickly as possible.

As it is to drive your company to profitability. Yes, there have been companies that have not become profitable until they've been at insanely massive scales. But you can count those on your fingers. Most likely, most founders are not going to be one of those people. If you are, you know, I just saw Base Power, Zach Dell's company. He's shooting for the moon. It's moon or bust. No question. That's always the way it's been since day one. The market he's going after.

His attitude on the world, and we have to call it out where he's coming from. And that's great. But most people are not that. and they're not as impressive as Zach. I had an opportunity to have a conversation with him a few years ago. Extremely impressive guy. Extremely impressive. Can't say enough good things about him. Really good, nice guy, too. But most people are not playing that game. And it's so unclear how big they're gonna be. And the name of the game is

Maintaining optionality. Do you want to be your own option bet or do you want to be somebody else's option bet? If there's one thing that you take away from what I'm talking about today, it's that. I'll repeat it, which is do you want to be your own option bet or somebody else's option bet? I'll run that back through everything I've talked about so far. Being your own option bet is taking a bet on yourself, which is the best investment anyone can ever make.

And the best bet anyone should ever make. And what that means in this case is building a business that accrues value on your terms, eyes wide open, and making sure that you can generate wealth for yourself that's in line with the value of the business that you have built. And when I say value, I mean real value, not hype value. To be somebody else's option is to get cloudy about the value of your business that you have built.

In the context of what is going on in the market due to momentum, supply and demand of capital, geopolitical whatever, and be misaligned with someone who is simply playing a different game from the game that you are and should be playing. Now, there's plenty of founders out there that would say, I don't have a penny to my name and it's billions or bust.

Ten years from now, I don't know, maybe they'll be saying the same thing, but maybe they'll also be saying, you know, I had an opportunity to make a hundred million dollars and I didn't take it. I don't know. Maybe they'll be living in a world where they're saying I wish I wish I I I know I was right. But most likely they're gonna be like, Man, should have taken the a hundred million. That would have been that would have been pretty nice. Because again, you can say you want to change the world, but you know, it's a lot easier to change the world with a hundred million dollars in your pocket than than it is

without a hundred million dollars in your pocket. So again, play your own option game. Don't let someone else play you as part of their option game and make sure that you can build your business to sustainable revenue growth because that is true freedom. That is power. That is wealth.

And if you have to flip to profitability, flip to profitability. But keep building great businesses. The technology and what's going on right now is extremely exciting. There's a lot of fluff out there, but there's a lot of real stuff going on. If you wake up in the morning and you need something to exist, go out and build it if you're the right person to do that. I encourage people to shoot for the moon, but understand that there's a lot of ways to optimize the route there.

So that even if you don't make it all the way to the moon, you can still be really happy with where you end up. Thanks for listening. Hope this was helpful and informative.