In this episode, Dan Gray and Daniel Faloppa discuss the current state of the startup ecosystem, focusing on Q1 insights, the impact of AI on funding, valuation trends, and the challenges faced by European startups. They explore the dynamics of investor behavior, the IPO landscape, and the implications of raising capital too quickly. The conversation also touches on the evolving nature of private markets and the importance of transparency in secondary markets, ultimately highlighting the need for a nuanced understanding of capital raising strategies.


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Takeaways

Understanding the current market cycle is crucial for startups.
AI is changing the landscape of startup funding and growth.
Valuation trends indicate a flat market with potential risks.
Investor behavior is influenced by market pressures and expectations.
European startups face unique challenges compared to their US counterparts.
Optimism plays a significant role in startup valuations.
Macro trends indicate a shift towards stability in the US economy.
AI funding is becoming increasingly concentrated among a few players.
The dot-com boom offers lessons for today’s AI investments.
Transparency in private markets could enhance investor confidence.

Chapters

00:00 Analyzing Early Stage Funding Trends
03:51 The Impact of AI on Startups
08:09 Valuation vs. Price: Understanding the Disconnect
12:38 The State of European Startups
17:27 Future Outlook and Strategies for Growth
25:55 The Dynamics of Deep Tech Investment
30:04 Shifts in Global Economic Strategies
31:46 AI’s Dominance in Venture Capital
35:43 The AI Investment Bubble: Current Perspectives
44:09 The Changing Landscape of IPOs
55:45 The Future of Secondary Markets
58:00 The Dynamics of Market Bias and Valuation
01:00:28 Transparency in Crypto vs. Traditional Markets
01:07:31 The Impact of Fundraising on Startup Success
01:14:13 Navigating Capital and Growth Strategies

Transcript

Dan Gray (00:00)
so we’re now at episode 14. And for this one, we’re doing kind of a like a state of the market for Q1 going through a few of the reports that have been released, some of the interesting market data, Angel List, CB Insights, some of our own data as well from the valuation Delta quarterly.

So what do you think? Should I get into it and start sharing some of the first charts?

Daniel Faloppa (00:20)
Yeah, definitely. think we are looking at data on investing very critically these days and trying to understand whether us and others are doing the right things in the early stage fundraising. so hopefully we bring the discussion forward today.

Dan Gray (00:36)
Yeah, and I think there’s, as always, like an opportunity to learn from recognizing the part of the cycle that we’re in today and how it has happened repeatedly in the past. And you you can see that in some of the research and the data that we’ll look at. there’s a lot that can be learned and a lot of problems that could hopefully be avoided through this kind of perspective. Okay, let me pull up.

The first chart. Okay, so this is an interesting illustration from Angel List’s State of US Early Stage Venture and Startups report that just came out. And it’s quite a simple, but I think like elegant look at how the supply of capital, how when that changes, also changes the supply of startups and the creation of startups, which is quite interesting. There’s a lot of speculation about whether

as you go through boom and bust cycles or even like recessions, do they produce more startups or more successful startups? But certainly it seems at the moment that the supply is a bit constrained.

Daniel Faloppa (01:31)
Yeah. And like we’ve seen our data and we will talk about those and also in the report from AngelList, their main message is that we are holding on to like this sort of bottom that we reached from 2023. I mean, it seems like it’s definitely related to the supply of capital, right? There is no reason for people to start less companies. The number of people that are

not part of the workforce, the traditional workforce is at an all-time high. Those are the people that start their own ventures, that start their own hustles and freelancing jobs that turn into companies. That’s at an all-time high. Opportunity seems to be fairly high for solo workers and idea generation, idea creation, and idea execution. So the constraint seems really to be on the financing side for the past.

Dan Gray (02:19)
Mm-hmm.

Daniel Faloppa (02:25)
year and a half.

Dan Gray (02:26)
Yeah, it’s also interesting to think about how AI changes this. I’ve seen a lot of investors talking about in this new world of AI, founders necessarily need to raise money? And if they’re not raising money, or at least if they’re not raising it as soon, perhaps they can build out more before they do need to raise money. Maybe they’re not like on the radar of someone like AngelList.

could be that we find they raise a bit more later on or maybe don’t at all.

Daniel Faloppa (02:54)
Yeah, it could be. mean, there is like a 10 year trend of like people reporting their first round less and less. I remember like when we started like all this little 50k, even 100k super tiny rounds, they were reported and they were in crunch base or in other places. And then people started to shy away from reporting very small rounds as they became almost like more of a negative signal than a positive signal, which is kind of strange still, but the…

Yeah, the AI question, the way that I’m thinking about it is on the one hand, if you are doing foundational models, you’re gonna have to raise like multiples more than what you had to raise a few years ago in the tens to hundreds of millions, two more as we are seeing. And if you’re making like this more like wrapper type of companies,

Dan Gray (03:39)
Mm-hmm.

Daniel Faloppa (03:51)
or let’s say applied AI to a very specific vertical, you could potentially raise less. What I think is like the game is still to be figured out as you might have to raise a lot less for your product, but you might have to raise a lot more for your distribution if you don’t manage to own the distribution because that’s like this incredible supply of like content that is coming out and articles and…

It’s grabbing an apps and everything is grabbing so much attention from the final user that distribution really becomes the key. And that’s why you’re seeing multi-million dollar influencers, right? They own that distribution. can demand those prices. so, it’s difficult to say whether it’s cheaper now to build something, to get something to, let’s say, product market fit.

compared to like two, three years ago. Yeah.

Dan Gray (04:51)
Yeah, that’s a question. I wonder how much when Angel List talks about supply of capital, if they’ve factored in like the concentration going into those few giant companies and actually what’s left is even less than it may seem perhaps for everyone else.

Daniel Faloppa (05:06)
Yeah, yeah, yeah. So that’s the other phenomenon happening. think on our data, we don’t see big changes of required amount of funding, right? So it doesn’t seem like things are getting more expensive or cheaper. It seems like things are stable.

Dan Gray (05:18)
True, that’s pretty flat.

Yeah, if you consider fundraising target, know, a lot of the guidance, a lot of the common wisdom, you think about that like 15 to 20 % dilution that you should aim for. And I think for all that that’s not really true, you should raise what you need, rather than trying to hit like an arbitrary target. I do think that shapes a lot of what happens. So as long as valuations are flat, probably the average target raise is going to be pretty flat as well.

Daniel Faloppa (05:52)
Yeah. And I think as long as the business model doesn’t become more commodity, I don’t think anybody has figured out what’s the next, let’s say the next SaaS, right? For a SaaS, can predict more reliably things, and maybe there is more uncertainty in predicting this, even the AI wrapper type of economics. Maybe that’s…

that makes it more difficult to forecast and to raise the right amount. But we did see some research that says it’s still worth doing, right? So that’s, well, something that we’ll get into.

Dan Gray (06:22)
Okay, the next one is like, it’s probably my favorite chart of the Angel List report. a somewhat complicated one, so I can walk through it a little bit. This is basically showing across the seven different vintages, which is like fund years, VC fund years. What is the growth in like paper value of their investments?

So how it’s marked on paper rather than actual like realized returns. And what you can see, which I think is like quite a worrying trend is a rapid acceleration for every vintage up until 2022. And then they flatline, which is consequence of a number of things, primarily the obviously the rising interest rates, the more constrained capital. So all of the…

the growth that they may have been hoping to fund in those startups after that point suddenly evaporated. They couldn’t do it anymore. also, know, unsustainable business economics were no longer sustainable. So a lot of those companies have wound up or taken acquisitions at, you know, perhaps not very attractive prices.

And that the headache that investors have at the moment of trying to reconcile these things, the amount of time it would take for some of these companies to reach the value that they’ve been marked at in the past now is just unreasonable.

Daniel Faloppa (07:41)
Yeah. And we like some of it is like could have been seen, right? Like the late 2021 and mostly from the investor side, because the company itself is not going to say no to money. Like maybe should and like did like topics of stock options, topic of down rounds afterwards and problems related to that. But

in general, the investor should be the one probably pulling back and saying like, hey, this is nuts. There is no future state of the world where you’re going to make back this capital. You’re going to make the returns that I need if we invest at this valuation. And it didn’t happen. It was an unprecedented period with COVID, with incredible investments from countries. But yeah.

It’s of course, and it’s easier in hindsight, but it seems to be something that we should try not to repeat because now the environment is stuck for a year and a half. I think the AI sector is in its own narrative, but everything else has been fairly stuck and good companies that were providing value to customers and to their own employees as well.

Dan Gray (08:46)
Mm-hmm.

Daniel Faloppa (09:03)
have to stop because they don’t raise the capital that they would have raised in a normal scenario just because everybody got burned.

Dan Gray (09:10)
very true. And this, this also connects with the conversation about incentives and how basically, when an investor first invests in a company, there is proper pricing tension because they want more ownership and the founders want less dilution. the two, those two forces kind of interact to get like to a fair price in an ideal situation.

second round, third round, et cetera. It’s now more in the interest of that investor that that price goes up because then they look good, their investment looks good. They can raise more funds, collect more management fees, et cetera, et cetera. So you lose that. The one thing, like the force that keeps it in check is suddenly gone. And everybody kind of rides this momentum up until the point where the market crashes and some people get out and make bags of money. Most people don’t.

Daniel Faloppa (10:01)
Most people don’t, but also most investors don’t, right? And we are seeing the very large contraction in IPOs as well. So that’s not a strategy to get out anymore. You end up staying private for longer. You end up with the following investors putting crazy liquidation preferences. Well, not crazy, very high liquidation preferences. then it’s not, I don’t think it’s a good outcome for anybody. The other mechanism there,

Dan Gray (10:21)
Mm-hmm.

Daniel Faloppa (10:29)
is the auction one, right? The only investors that are gonna win the deal are the ones that believe in it the most, maybe to some irrational levels, like to some exaggerated levels, right? But again, I don’t think we can change the auction model just because the company has those incentives to raise at the highest valuation. We probably should, but it’s pretty difficult.

Dan Gray (10:55)
Mm-hmm.

Daniel Faloppa (10:59)
but.

Dan Gray (11:00)
Yeah, but I think

in the past, like the auction model kind of worked because it was…

It was basically how the founder would use competing bids to try and get to a price that was reasonable against investors that want the price as low as possible. Whereas now there’s so much money that it’s become literally what is the absolute maximum amount of money I can make from the person with the biggest wallet in the room. And that’s where it gets crazy.

Daniel Faloppa (11:24)
Yeah, yeah.

And what we were also saying a few days ago is this becomes also then a signal for the next startup that if they want to hire the best people, if they want to compete fairly on the PR market or whatever, they need to raise at those levels as well. And that forces everybody to, if they cannot raise at that, because the headline is only the valuation, then this forces the other companies to put in even more guarantees, even more liquidation preferences.

skewing the returns even more towards investors rather than founders and employees, where if the exit is really not incredible, then nobody makes money aside from the last investor that has 3X, 5X liquidation prevalence.

Dan Gray (12:11)
Yeah, yeah, that’s a great point. think employees

get get lost in that conversation. But if you look at this chart, and you think about those companies, in on those like kind of big inflection curves, they probably had a super easy time hiring because they were offering stock options to to talent and saying, look at how fast we’re growing, you’re going to make loads of money off these and then suddenly, it flatlines and those those options are worth, you know, much less than than they were kind of sold at perhaps.

Daniel Faloppa (12:38)
Yeah,

yeah, yeah. Interesting. I think another point on the Angel List report was on down rounds, right? So I think down rounds are up like twice as many as regular years or something to that extent. And so if you look at this chart, this becomes then the average between companies doing an up round and companies doing a down round, right?

Like you can see that in those portfolios, is likely that, you know, let’s say a certain percentage, let’s say half is doing a down round. I think it was like 60 % doing a down round and the other ones are doing up rounds just enough to compensate for those down rounds. So, yeah.

Dan Gray (13:22)
Yeah. And then that excludes

all of the companies who have done convertibles, bridge rounds on safes, because they don’t want to reprice the company. So they just do a safe and hope that when it comes to the next price round, they can pull everything back together magically and, know, fingers crossed for them.

Daniel Faloppa (13:39)
Yeah, yeah, yeah. And I think now we’re seeing those getting to the end of the rope, right? Like it’s been like a year and a half that raising has been a lot more difficult. We see it in our data as well. And that’s normally what you raise for, right? A year and a half, maybe two if you’ve been cautious and if you cut costs and stuff. And I think that’s what’s happening now. We are seeing a restart of the ecosystem.

but it’s also a lot of companies that are folding. A lot of accelerators we were talking this morning are folding as well. And they got to the end of the rope.

Dan Gray (14:16)
Yeah, it’s funny, I had a bet with Pete Walker that 2024 would see fewer startup closures than 2023. Because my thinking was by the end of 2023, most of that reckoning should have been over with. And you know, it kind of like the the big short, the movie where they’re watching the markets and like waiting for everything to crash, but the banks keep it all propped up.

somehow it’s kept going a bit longer than perhaps was rational. like the one time I’ve been a real optimist, it hasn’t worked out for me.

Daniel Faloppa (14:49)
But it is kind of the same, right? Like it’s plus minus 3%. It hasn’t really gone into either of those two directions, I don’t think. It hasn’t crashed, it hasn’t exploded. It kind of kept the same level for the past two years.

Dan Gray (14:58)
Yeah, true, true,

Yeah, but the same concerning the high level relative to previous years, although then maybe maybe in the kind of decade of low interest rates, the the survival rate was too high slightly because raising money was so much easier. That’s another consideration.

Daniel Faloppa (15:22)
Yeah,

yeah, yeah, I mean, for sure, right? Like a lot of closures of companies that were unsustainable and that were kind of designed to be working only in that specific economy. Those ones are not existing anymore. A lot of fintech, especially, that was really, really booming in 2021 was the first thing to go down. Fintech is also connected to interest rate in the product.

Dan Gray (15:24)
Mm-hmm.

Mm-hmm.

Daniel Faloppa (15:51)
And yeah, it hasn’t worked out for them. So the interesting thing is definitely on the company side, the ones that do survive, they have an easier time. They have less competitors. They have probably more capital availability as soon as things restart on that side, which I don’t think they have. yeah, a lot of them had to fold over the past years.

Dan Gray (16:12)
Mm-hmm.

Well, speaking of optimism or lack of it, next, we’ve got some of our dates from the latest valuation delta quarterly. So we’ve got at the top, that’s the global pre-seed valuation as a median with top and bottom quartiles and the fundraising target as well. can just about make out. And you can see from the global trend, like that’s been very steady. It’s marginally above where it was in Q4 2021.

So that you had the kind of big initial dip when there was the panic about everybody wanted to get to profitability, all the money had dried up, venture capital was dead. Then that seems to have rebounded, which was more than anything, probably like a flight to quality. Fewer better startups managing to raise money in that period. And it’s been more or less flat since then. Down slightly on 2023, recovering over the last year as well.

We’ve also highlighted Europe just for contrast, which is interesting because Europe’s the only region which has actually seen a decline in the median in that period. And we can talk a bit about why.

Daniel Faloppa (17:27)
Yeah, there aren’t many positives for a good old Europe in this period. Technology wise, we missed a few too many waves. Policy wise, investment wise, just like the, I mean, the Draghi report highlighted this. Our previous podcast episode with Robin Wouters as well highlighted how Europe has been left behind quite a…

quite significantly, I think about a third of the economic growth of the past 10 years that the US has had, we haven’t had. So it’s very, very significant difference now. And I think a lot of people, well, me included, we grew up with that idea that Europe and the US were on the same level in terms of…

purchasing power and lifestyle and things like that. Over the past 10 years, they have diverged incredibly, at least if you look at the data, but with the US having…

Dan Gray (18:16)
Mm-hmm.

I think since the global

financial crisis, more or less, was when the two started to really diverge.

Daniel Faloppa (18:29)
Yeah, yeah, yeah. And of course, that probably started with all this burden of all the debt that we had in Europe and stuff, but also the incredible lack of productivity, the lack of a joint market, the lack of a joint workforce, and a little bit of not catching the right trends. So now…

Dan Gray (18:46)
And in the last few

years, obviously Ukraine, energy prices, both of those have been a significant negative force.

Daniel Faloppa (18:56)
Yeah,

yeah, yeah. And I do still think there is no strategy on how to react to this. There is no strategy meaning leveraging uniqueness, leveraging anything really to try to get ahead is not really happening. The hands are also tied for a lot of budgets and other things, but…

Dan Gray (19:08)
Yeah.

Daniel Faloppa (19:17)
But yeah, so we’re seeing this in startups as well. The recovery of valuations hasn’t really happened. If you look at this chart, it’s fairly flat, it’s declining a little bit, but we need to remember that we had inflation through and through. So this is nominal, it’s not corrected for inflation at all. So we have stable slash declining valuations where the actual cost of everything went up.

Dan Gray (19:38)
Mm-hmm.

Daniel Faloppa (19:45)
then it depends who you listen to, but 10 to 20 % in the past three years. This is three years of data. So you see that maybe that uptick in capital requirements is because of that. Salaries have gone up, costs have gone up. You need to raise more capital, but the perspectives of the company, the future that the company can have in this type of economy is the same or lower compared to what it was three years ago.

which is tough to see, right? If you look at Latin America, Latin America suffered a lot. They had their own narrative, right? Like massive foreign investments in startups during the boom, and then it really got worse, but now it’s really recovering, at least from our data. Africa, the same. Southeast Asia is doing okay. Europe has been really left behind.

Dan Gray (20:36)
Mm-hmm.

Yeah, and I think something we’ve talked about a fair amount, specifically in regard to to pre-seed valuations, is the extent to which on a on a very broad level that they’re kind of a reflection of optimism. So I think, you know, it’s kind of reasonable to say, if you look at the last five years, the world as a whole is like, moderately optimistic, like, there’s certainly a lot of turbulence, like, but it’s not

terrible either. can obviously see the influence of things like COVID and we can even see the waves of COVID and the vaccine rollout kind of reflected in the valuation data in a way and how that shapes optimism. Because essentially those investors are looking not at today, like this is a company that’s going to exit in five to 12 years, something like that. what is the future going to look like? Do they fundamentally believe

it’s going to be better or worse. And it’s kind of, you know, says something about Europe that there’s been a steady downtrend. And yes, it’s partly explained by the things we talked about. but also like, there’s a lot that could be done, like there’s low hanging fruit that would help generate more optimism around European tech.

Daniel Faloppa (21:51)
Yeah. Yeah, I think also, and this might be a sample of one type of observation, but I think the perspective, like the most daring perspective or like future, possible future for European startups has changed. Like if like maybe 10 years ago, there was this idea that, yes, you could build maybe like a DecaCorn or at least like a strong unicorn.

in Europe right now, I see it a lot less. You see the, I don’t remember if it was unicorns, but like the fact that this, like the top 10 largest companies in Europe have been the same for like 40 years, right? So I think there was back then that ambition that it could be done. And I think now that ambition is much smaller.

You make your national leader. You might make a little bit of a European leader, but at least on average, right? Yeah, so that is also reflecting, I think, then in the valuations slightly.

Dan Gray (23:00)
Yeah. Yeah, that does.

I’ve seen a number of people talking about this war on talent, is particularly an issue in relation to AI, where this was a British investor talking about British AI companies and how they are being actively targeted by the US and by Saudi and think by UAE to move their companies over there. And if you think in terms of Europe, a lot of European founders have

traditionally moved to the UK as seeming like a friendlier business environment for startups. And now they’re being pulled out of the UK to other places as well. it’s like the threat of brain drain in Europe for as long as this optimism isn’t there, or certainly for as long as it’s not increasing, it just gets worse. It’s kind of like a reinforcing thing as well.

Daniel Faloppa (23:49)
Yeah. Yeah.

Yeah, mean, the competitive field is bigger. And I found that these days, well, like maybe 10 years ago, they were thinking if they were from little village in Portugal, they were looking at the rest of Europe. Right now, they’re looking at Singapore or Dubai or San Francisco directly. that’s, yeah, that has definitely changed a lot. And of course, on the hiring as well. mean, aside from the…

Dan Gray (24:09)
Mm-hmm.

Daniel Faloppa (24:23)
like the fact that we are here and that is not nice, but otherwise, you know, that’s in theory, everything working correctly. Apart from, you know, when like large countries really distort this type of balance, which is the case for at least the Middle East, the US, like these incredible amounts of governmental funding that then every country has to match. But other than that, it’s…

Dan Gray (24:30)
Yeah, true.

Daniel Faloppa (24:53)
Yeah, it’s the system working, Especially as a company, you just go where you have the highest probability of success. There is no other alternative. There’s no choice really.

Dan Gray (25:03)
Yeah, yeah, a bit of an aside, but you just made me think of the the announcement I think it was earlier today or yesterday at the new Trump gold card visa scheme in the US, you pay 5 million and you get the right to go and live and work in the US. How many investors is that a brilliant idea? Because if they want to pull a company over to the US before they had to worry about, you know, dealing with visa issues.

Now they just say, a part of our investment, we’re going to give you five million for each of the co-founders and you all come over here and it’s all sorted. Like that’s, that’s kind of genius.

Daniel Faloppa (25:36)
Yeah.

Yeah, I’m still optimistic that there are reasons to be in Europe. are, like, know, like quality of life and sort of the things that you have to worry about are a bit different. But that’s why, like, it does need its own specific strategy, right? Like, what are those conditions helpful for?

Dan Gray (25:55)
Mm-hmm.

Daniel Faloppa (25:59)
For example, deep tech, right? Deep tech benefits from lower costs, high talent, longer time horizons, longer investment horizons, maybe more capital constraints. I don’t know if there is research on this, but maybe a bit more constrained capital helps creativity. Could be, but as long as there is no strategy, then it’s really hard. And every country is doing its own thing and they’re doing it.

for a very, very short amount of time. You cannot do something in deep innovation for two years and then stop it and hope to have unicorns 10 years later. It just doesn’t work, I don’t think.

Dan Gray (26:36)
Yeah, yeah, very true. I certainly we’ve seen and I think we’ll talk a bit more about the relationship between amount of funding and success and how it’s not a it’s not a correlation exactly. And that Yeah, I think that’s a that’s interesting. Like that that in itself is probably a whole nother podcast episode, but it lines up with evidence that VCs in Europe actually perform better than the US and perhaps it’s because they have that constraint. They don’t operate.

Daniel Faloppa (26:55)
Yeah.

Per dollar.

Yeah.

Dan Gray (27:04)
Yeah, exactly. Not on the same

scale, but on a per dollar basis. They have better returns. So talking about big picture macro stuff, you highlighted this article, which I read, but I think you have a better grasp of the topic. So maybe walk through this a bit.

Daniel Faloppa (27:19)
Yeah, yeah, so I always like what the research at Bridgewater is doing in trying to understand the macroeconomics and the sort of the really big shifts and the really big trends that are shaping economies.

From their point of view, and of course, they’re much more immersed in the US economy, the US is now reaching an equilibrium. So it doesn’t have overvalued assets propped up by debt or things like they were before the financial crisis. It’s not being propped up by weird dynamics in the market.

like during COVID and after COVID, they are reaching like some sort of a steady state. And I think that’s quite interesting, right? Maybe that’s something that at least in the US companies can build on and like sort of rely on that we’re getting to normal quote unquote interest rates, normal inflation of like, you know, around 2%, 3%.

And that’s another story why that is healthy. And that’s an economy where companies, investors, and everybody can build and rely on, which is quite a luxury to have, I think. This is still separate from the, for example, incredible investments that are going on in AI and things like that. But when you look at the macro picture over the whole continent, pretty much, it’s quite interesting.

Dan Gray (28:48)
And it’s quite a contrast to the, let’s say, political turmoil in the US. Like, on the economic side, it’s quite stable at least.

Daniel Faloppa (28:54)
Yeah, yeah, so yeah, exactly.

So this article is from the 31st of Jan, right? So there were still no effects of extreme policies. And I do think they are extreme, like nobody ever like sort of carpeted 25 % tariffs on half the world before.

Dan Gray (29:14)
Yeah, pre-trade war.

Daniel Faloppa (29:16)
Yeah, so those are incredible shifts that can happen. And I don’t think Bridgewater or anybody else forecasted those type of changes so rapidly and so large in magnitude. So yeah, so for that, we’ll see. For that, we will see. What I think is clear is that we are moving from…

like a global world, a global market to an internal one, right? Even if those tariffs are not gonna happen, even if they’re all gonna be retracted, just the possibility that that’s gonna happen is changing strategies of everybody, right? And I think Apple just announced that they’re gonna invest in US factories. Overall, again, like my personal opinion is…

Dan Gray (30:05)
Mm-hmm.

Daniel Faloppa (30:12)
waste of money for everybody, right? It’s like attention and innovation and focus and resources that go into like separating us, making us less diversified, less reliable, less specialized. so everybody has to make their own weapons, for example, right? Everybody has to make their own AIs. We cannot just rely on the top in the world. So just like the speed of innovation,

worldwide is hampered by this. Even just the fact that it could happen hampers the innovation worldwide and changes strategies for everybody.

Dan Gray (30:52)
all bad though? I’m trying to

kind of do like the best case scenario here. Now that we have a world where, for example, Europe is being forced to step up a little bit more, like on the defense side, that’s one thing, but like in general, there’s a lot more talk about Europe being competitive with the US on innovation, on startups. You know, like there’s positive to that,

Daniel Faloppa (31:18)
Yeah, yeah, fair enough. But it’s a positive that comes out of pain, right? It’s a reactionary positive and yeah, still a positive. it have been achieved without the pain? That’s a question, But I don’t know. I think…

Dan Gray (31:27)
Great cast.

Daniel Faloppa (31:46)
Well, I mean, and then again, it’s a philosophy, right? But I think we could have done better, but that’s where we are.

Dan Gray (31:54)
All right, next up we have the CB Insights report, State of Venture 2024. So this slide I picked out particularly, this is just showing, I think the by now expected increase in AI as a percentage of the total funding is now up to 37 % of all venture capital funding and significantly concentrated in

Databricks, OpenAI, XAI, Anthropic, all the names that we know. And you can compare as well how it reflects as a percentage of the dollars and a percentage of the deal count. So it’s only 17 % of the deal count, but 37 % of the dollars, which shows how expensive these deals are relative.

Daniel Faloppa (32:43)
Yeah. Yeah, it’s interesting. I think an additional data point on this is they were, I saw like the same data for when there was the crypto boom, right? So Web3 and the percentages were much lower. like even when…

So like in a sense, the focus on AI at its peak, or we don’t know if we are at the peak, but it’s still much higher than the focus that we had on Web3 at its peak and NFTs and like that whole period, right? So it’s definitely central to the innovation conversation. I mean, like when I look at this, like I’m thinking 17 % of the deals is actually not that many. Like I would have expected more.

Basically, everything that Y Combinator is talking about is AI. So that seems to be their own specific strategy, maybe based on their own previous successes and so on.

Dan Gray (33:41)
Yeah.

That’s true, but that depends on the very tricky question that we’re very familiar with of how do you classify these things? Is a logistics company that uses AI for route mapping, is it an AI company or a logistics company? And yeah, I think that’s one of the many areas where the reporting on venture activity is sometimes misleading or misunderstood at least.

Daniel Faloppa (33:55)
Yeah.

Yeah. Yeah. But yeah, still, I think it’s a super important trend. What more can you do with this data, right? We saw before that following these trends as a company doesn’t help, right? The companies that are winning on the AI race now have been started. OpenAI was started like…

12 years ago or whatever it is. So, you know, this is interesting. It helps recalibrate a little bit. Yeah, if you do logistics and you have a little bit of AI, you know, try to put that AI in your deck as much as possible. Like, further than that, you know, right? I mean…

Dan Gray (34:56)
Yeah.

Yeah.

Yeah, it’s a question I ask a lot because I think it’s really interesting is to compare like that. The closest comparison I see between AI and anything else is probably the dot com boom. lot of similarities in terms of, know, it was clearly important technology. It enabled a ton of infrastructure to get built as we’ve talked about, I think, two episodes ago. But it was a huge bubble, and it burst.

And you could see that like 95 to 97 or 1994 to 97, all mostly good investments, mostly made money. The ones after that mostly destroyed capital. So like where in that cycle are we today with AI? That’s, yeah, don’t Yeah. And it’s an interesting question because it’s acknowledging that AI is a bubble and that we’re in there somewhere, but where? Like, are we still on the up or are we now on the down?

Daniel Faloppa (35:43)
Mm-hmm. Mm-hmm. Yeah. That’s the question. Yeah.

Dan Gray (36:00)
and I’m not entirely sure.

Daniel Faloppa (36:02)
Yeah, me neither. I like to think that we are still on the up, just because it just sounds so exciting to see how can we reshape everything. I do think the customer impact right now of AI is close to zero compared to what the full extent is going to be.

Dan Gray (36:14)
Yeah.

Daniel Faloppa (36:26)
And the final value creation is on the customer impact, right? So like the way that the word as a whole creates value is by making the lives of people better, right? Then we translate that in money and better means a billion things and different things for each individual. like progress basically is at least the way that we’re measuring it right now.

Dan Gray (36:45)
Mm-hmm.

Daniel Faloppa (36:53)
making the lives of people better, even if that better means like maybe doing less or maybe consume less or whatever, but it’s still making people feel that they have more value in their life. And so that’s on the outcome. So what does the word build? And like with AI, you can still, in my opinion, influence that a lot. On the other hand is like, how do we grow that pie? How do we give more value to everybody is through specialization and productivity.

And for that, also think, like AI, maybe it’s a bit more advanced there, maybe like, say, 5 % of what it can do. And I’m talking about current models with much better agents, like not talk about like AGI and incredible things, right? But current models with better agents, I think just that impact is still, we’re only…

touching the tip of the iceberg there.

Dan Gray (37:51)
But there,

think we could differentiate between the bubble from an investment perspective versus the hype versus utility. Because the dot-com bubble exploded in 2000, but clearly the internet kept getting better and more useful and added productivity. there’s a bit of a difference between the two. I would say, and this is me being the cynic as usual, this year we’ve seen like

Daniel Faloppa (38:04)
Yeah.

That’s so true, yeah. Yeah.

Dan Gray (38:19)
DeepSeek raised questions about whether all of the investment that’s gone into AI has been well spent, let’s say. You had Microsoft potentially pulling back from the Stargate project, not going through with some of the commitments that they had on data centers, I believe the story was. That’s a bit worrying. And then this quarter,

the earnings for Nvidia were like for the first time they didn’t blow through their forecast. So like that’s also a bit of a surprise I think to some people but despite all these announcements despite Stargate and virtually every AI giant saying they’re going to spend more and more it hasn’t reflected in Nvidia’s earnings.

Daniel Faloppa (39:03)
Yeah, yeah, no, that’s true. And the, and it is indeed, right? So, so like, if the potential is there, but then the investment carriage gets in front of the horses of like the cashflow horses, basically, then, then, then you have, you have a burst and then it can still grow after that. Yeah, that’s a good question. That’s a good question. I think, you know, like when you look at the, super large

Dan Gray (39:16)
You

Daniel Faloppa (39:32)
investments, yeah, maybe there is bit of cracking in the walls. What is happening, I think, on the earlier stages is this whole conversation around wrappers, basically. And it feels like until one month ago, was, okay, wrappers are completely worthless. And then now wrappers could be worth something.

Dan Gray (39:47)
Mm-hmm.

Daniel Faloppa (39:58)
And then some people saying, everything is a wrapper, which yeah, it’s pointless to, to, discuss. Like we’re talking about, we’re talking about competitive advantages. They can be sustainable or not. Like we, you know, shortcut for that rappers. are you building a sustainable competitive advantage? If so, you can defend and accumulate value for yourself. If not, like you make it open source, for example, it’s not defensible.

Dan Gray (40:03)
you

Yeah. Yeah.

Daniel Faloppa (40:25)
you create lot of value for other people and you hope to capture a little bit of it.

Yeah, I don’t know. I think we are learning a lot about that, but on that side, I don’t see crazy valuations for crazy companies. It’s more really in this data centers type of things and foundation models type of things, AGI-hyped companies, former companies or former employees of OpenAI that haven’t done anything yet and they’re already worth…

a couple of billions. yeah, on the really the sort of vast majority of AI companies trying to do something in a vertical, trying to create value for the customer, I don’t think valuations are worrisome. Yeah.

Dan Gray (41:19)
Mm-hmm.

It has been interesting though going back to what you said about wrapper companies, the rebranding. It’s not wrapper companies anymore, it’s now application layer.

Daniel Faloppa (41:30)
Yeah, yeah, but it is true. one thing that we are seeing, and I think people are underestimating a lot, is AI solutions come with a ton of maintenance. If you do have a little AI feature on a website that otherwise is not AI, like let’s say you have AI customer support, right?

Dan Gray (41:42)
Mm-hmm.

Daniel Faloppa (41:54)
you don’t want to be the one maintaining that customer support system, like the actual infrastructure, the AI behind it and so on. Because the whole speed at which AI is evolving requires so much maintenance, so much specialized knowledge that if your business is not making AI for customer support, you’re probably better off outsourcing that and focus on your core value proposition. So in that case, the customer support, which is substantially an AI wrapper, and then it can differ in how much it wraps.

Dan Gray (42:15)
Mm-hmm.

Yeah.

Daniel Faloppa (42:25)
how

thick is the application layer, it can differ. But I do think from a customer perspective, it’s still worth outsourcing this to somebody that can spread the cost of maintenance across multiple customers. And that makes it a fairly defensible competitive advantage. It becomes, as I was saying before,

like your competitive advantage there because making that wrapper is not that difficult needs to be on the distribution and on the customer relationships. And how you do that is then the question, but I think possible.

Dan Gray (43:04)
Mm-hmm.

Yeah, customer service particularly is an interesting example. I it’s another piece of this is companies trying to figure out how to use AI properly. So one of the early success stories of AI was Klana. You know, they froze hiring, they tried to transition all of their customer service to AI essentially. But in the last week or so, the CEO made a statement like that, once again aiming to be

a company where customers can talk to people. like that, I think they didn’t quite get what they wanted out of the transition. It hasn’t worked quite as well as they hoped. I’m like, you know, it’s, that’s kind of two schools of thought, which is very interesting. Like, AI replaces the need for humans, or AI really amplifies the qualities that humans bring to a business. like customer service, sales are both

Daniel Faloppa (43:37)
too bad. It was…

Dan Gray (44:00)
always going to be super important to have good people.

Daniel Faloppa (44:03)
Yeah, no, was, I was just joking on the, on the too bad because they probably like, they just filed for IPO as well. Right. So they, so they were probably trying to capitalize on this AI hype even more for their IPO, but then they had to announce that they cannot, right. At the, the last moment. Interesting. Interesting. But yeah.

Dan Gray (44:10)
Hahaha

Yeah. Yeah.

Yeah, very interesting. Speaking of IPOs,

Daniel Faloppa (44:31)
Indeed.

Dan Gray (44:31)
that’s a good transition. The next slide from the CB Insights report is this. So this is the amount of time from first funding to IPO for VC-backed And as you can see, since 2015, that has gone up from just under five years to now seven and a half years. And this is essentially a consequence of there being so much more money available. It used to be that you would IPO

to be able to tap into public market liquidity, now you don’t need to. And especially, look at the size of the funding rounds going into XAI and Anthropic and OpenAI. They have no need for it, which is, I think it raises a number of concerning questions.

Daniel Faloppa (45:15)
Yeah. Yeah. Yeah. Yeah. Public markets are, in my opinion, very good, right? It’s for everybody. like, an efficient market raises the outcomes for all the players, right? And how it does that is by increasing trust. And we talk about this also in normal fundraisings, right? Trust is critical and maintaining expectations, communicating the risks.

When you do that, you increase trust and you increase price for the same outcome, for the same risk and return of that outcome. So public markets increase outcomes because they facilitate liquidity, not only for large investors, which can call each other and have liquidity that way, but also for small investors, it increases scrutiny for the companies. That’s how you increase trust. But that, by and large, in my opinion, does increase value for all participants.

It might not increase value for the very, very few participants that have an incentive in controlling the narrative more. And that’s normally the management team slash founders and the main shareholders slash investors. And so the fact that we are doing less IPOs and waiting longer to IPO, I don’t think it’s in the interest of…

society at large.

Dan Gray (46:43)
Yeah, it’s become kind of like a prisoner’s dilemma where, yes, going public, you have reporting requirements, as you talked about, so you have more transparency and more trust. But if you’re the one company in that sector that doesn’t go public, you can now see what everyone else is doing. They can’t see what you’re doing. So you have that like slight advantage over them, which means now nobody wants to go public, which is not good.

Daniel Faloppa (47:05)
Yeah, plus the reporting requirements plus a bunch of… And

I think also the game used to be, from being able to access more capital, you were able to access capital at the highest valuations because it was… Like the company was trusted, you could access the largest pool of investors and so on. Now, and we go back to one of my recent gripes, so liquidation preferences.

Dan Gray (47:20)
Mm-hmm.

Daniel Faloppa (47:33)
With liquidation preferences, you can have a private valuation that is much higher or at least higher than what you would get on the public market, which disincentivizes IPOs even more. It could just be that companies are just waiting because in the past two years, there haven’t been the conditions to IPO much. But I think these trends are indeed deeper than just…

The past two years didn’t have the best conditions to IPO. When the company IPO is done, they need to turn all their stock into common stock. Liquidation preferences disappear. And then that creates this incentive for investors that do have those liquidation preferences to vote for an IPO. On top of that, they invested incredible amounts of capital. They got maybe a larger say in…

whether the company IPO’s or not. And it used to be also investors wanted to IPO because they wanted to exit, right? But now we have like rolling funds and so on, so they don’t need to exit. And then we end up with less IPO’s to the detriment of society at large, I think. Yeah.

Dan Gray (48:34)
Mm-hmm.

Yeah,

certainly to the detriment of investors. you know, we talk about continuation funds. Yeah, yeah, absolutely. And even secondary markets, of course, there’s a slide on that in a little while. But you can still look at the graph of distributions going back to LPs. And you can see even with these innovations that are providing some liquidity, it’s still not great right now.

Daniel Faloppa (48:51)
Small investors and early investors. Yeah.

Yeah. Yeah.

Dan Gray (49:12)
And

then we’ve got this from PitchBook. So this shows like this kind of illustrates what you were talking about. We’re now up to more than 600 companies who on a number of like typical metrics relating to growth, like age and size of capital raised, they are IPO candidates. These are companies that should be going public. But we now have more than 600 that can’t for various reasons.

Primarily, probably their financial health is not what it should be to be a public company. And they know just like we work, as soon as we work when public, everybody went like, this is terrible. None of these companies wants to do that.

Daniel Faloppa (49:52)
I mean,

I do think that was predictable. I don’t know. mean, it’s true other companies have flirted with that line before and they passed. But we were, I like I looked at the prospectus as well back then and it was clear. And I think in the risks, they said something like, don’t worry. Like the risk part was written so badly.

Dan Gray (49:58)
Yeah.

Daniel Faloppa (50:21)
that it was almost disrespectful. yeah, it was an interesting case. Yeah, this is only US, right? So I think even if you… There is an alternative theory that I can think about that just everything got… The scale got so much bigger that actually the companies that should IPO only when they get to 500 billion or when they need to raise 200 billion or something like that.

Dan Gray (50:28)
Yes, correct.

Daniel Faloppa (50:50)
I don’t think that’s the case. I don’t think that’s the case. think even smaller companies than that would benefit from the trust of a public market. But yeah.

Dan Gray (51:02)
Yeah, and

it’s another area where there is there is probably low hanging fruit. I know, for example, there is a bill in the US that they’re trying to get passed at the moment that would suspend reporting rights for IPO companies in kind of tech in innovations, innovative sectors, it would suspend their reporting requirements for two years, which like is maybe maybe a step in the right direction.

Daniel Faloppa (51:21)
Yeah.

Yeah, I would just remove liquidation preferences. Just make liquidation preferences illegal and…

Dan Gray (51:33)
Yeah, yeah, that’s true.

Well, yeah, then that kind of comes back to our conversation about employee stock options. If you solve the tax problem there, so you no longer need to have such a difference between like preferred stock price and common stock price, then maybe the whole problem goes away.

Daniel Faloppa (51:39)
You

Yeah, because then you would have fair valuations at every step. And if somebody really needs to raise, they can raise in a mix of equity and debt, which is basically, you can compose it and make it a liquidation preference, more or less. But then your equity valuation would be so much more transparent, and then there would be a big incentive in going public.

Dan Gray (52:08)
Mm-hmm.

Daniel Faloppa (52:25)
because you would increase the trust and that trust would automatically increase valuation and the liquidity as well, right? So the…

Dan Gray (52:30)
Mm-hmm.

Daniel Faloppa (52:32)
But yeah, I don’t know. Yeah, I don’t know if increasing the opacity of the public market is the right way to make it more competitive. Yeah.

Dan Gray (52:42)
Yeah, yeah, that’s true.

It has has its its has its downsides for sure.

Daniel Faloppa (52:48)
Yeah, the markets stops functioning when it stops being fair. And for example, you saw that in Italy when they try to put one-time taxes on banks, when banks do extra earnings, that just damages the trust in the market itself, in the Italian market for ages.

Dan Gray (53:12)
Yeah, it seems

like the better way to approach that would not be to say for two years, but it would be to say maybe below a certain size, you have less reporting requirements, perhaps, because then it encourages earlier IPOs as well.

Daniel Faloppa (53:28)
Yeah. Yeah, but again, right? If you have even the same reporting requirements, but you can raise on the private market at three X the valuation, because you can have liquidation preferences there and you cannot have them on the public markets, then there’s no point. You could allow liquidation preferences on public markets, but then you would have to teach everybody how to value different share classes.

Dan Gray (53:43)
Yeah, true.

Daniel Faloppa (53:54)
That’s not even done among experts now. So I don’t think that’s feasible. Yeah.

Dan Gray (53:58)
Yep, very true.

So in

the private markets, we have this list. This is the SETA 30. It’s kind of hard to read them from this slide. So I’ll go through a few of the top ones. This is basically the 30 companies that get the most requests for secondary market transactions. So quite predictably at the top, have SpaceX, then Andoril, Anthropic, Stripe, Databricks, XAI. That’s the top six. Then OpenAI is seven. Figma, Figure, Kraken.

So like also getting into like robotics and crypto, which is quite interesting, not just AI. But the question I have about this and secondary markets in general kind of relates to adverse selection. So because of this lack of transparency we’re talking about, you have all these companies at the top, which everybody probably kind of feels like they know very well because they’re in the media all the time. They have huge brands.

You have Elon Musk involved in a number of them. And these can probably all command a premium on secondary markets. they do. You’ll see SPVs adding fees on top of investing just so people can get into SpaceX, for example. But how far down this list do you have to go before that changes, before it’s…

instead of a premium, it’s a discount and then like an increasingly steep discount because of adverse selection. Like people don’t know the fundamentals of the companies. So they’re not willing to pay anything like the last round price plus all the concerns about last round price may be based on preferences, etc. So is there an argument that private markets would also benefit from more transparency? And how much would that

Daniel Faloppa (55:45)
soon.

Dan Gray (55:46)
building a healthier secondary market, would that be a good thing or a bad thing? Or should we really be aiming just for exits?

Daniel Faloppa (55:53)
Yeah. What’s your theory?

Dan Gray (55:55)
I know.

I have I like the idea of a secondary market in theory. I have a feeling like the way it’s designed today is kind of intentionally optimized for those giants with the big brands, because this is like the like Andreessen Horowitz channel to tap liquidity whenever they need it. They can sell shares in those companies and get a little bit of liquidity back to LPs. But at the moment, it has

close to zero utility for any smaller investors. If it was more transparent, that may be the other way around. But then look at where the interest and the money is. You can kind of see which way it’s going to head probably.

Daniel Faloppa (56:29)
Yeah.

Yeah, yeah. And that’s, I think that’s why you need the regulatory side, right? Because otherwise, yeah, you might start with a market that does have SpaceX, but then you’re going to end up in a few years with a market, with a lemon market, right? Only the worst companies are going to try to offload shares in these type of markets. The way that…

Dan Gray (56:45)
Mm-hmm.

Mm-hmm.

Daniel Faloppa (57:03)
in the public market this is managed is by a lot of scrutiny, a lot of open data, a lot of openness so that people can differentiate more or less and a lot of standardization in the instruments that you invest in. Because like even here, right, if you want to do a proper thing, indeed, if that last round has a 3X preference and I’m buying the stock options of somebody in the secondary market rather than buying…

the shares of the last round. The valuation must be substantially different than this. yeah, it’s a good question. It’s a good question. It seems for now, it’s a buyer market, right? So it’s like investors that are interested, they cannot get into the best rounds and things like that. And so they try to buy themselves secondaries. And so…

Dan Gray (57:39)
Mm-hmm.

Daniel Faloppa (58:00)
that creates like it’s a bias market, it creates these high prices, but it also is entered only by the best companies, quote unquote, which again, yeah, you’re right. It might be the most famous ones because the data is not there. But yeah, if you do this in an institutionalized way and you want to expand it like sooner or later, it stops being a bias market.

Dan Gray (58:17)
Mm-hmm.

Daniel Faloppa (58:28)
There is even an argument that why should it be a buyer’s market? That’s just by default a losing one for the buyers. Yeah, that’s a good point. Should it exist at all? I think the official secondary was public markets, right? And yeah, so…

Dan Gray (58:49)
Mm-hmm.

And that was seen as the line where a company was sufficiently de-risked and had these obligations about transparency so public investors could invest more responsibly in those companies. Whereas in private companies, as we’ve seen, there’s more risk involved. Although I’m not necessarily against the idea that individuals should be able to invest in private companies.

Daniel Faloppa (59:06)
Yeah. Yeah.

No, that’s true.

But you need to… We cannot end up with a market like the crypto one, where 95 % of things are, you know, rock pools or attempts at rock pooling. That’s the sad truth. It’s still happening. it’s, you know, the vast, vast majority of things that happen there. And people know it, right? And the behavior now there…

Dan Gray (59:27)
Mm-hmm.

Daniel Faloppa (59:47)
has almost nothing to do with value creation for 99 % of the companies or coins or whatever you want to call them. And everybody knows and they invest and it goes up and they just hope to get out before everybody else. So then it’s not a value creation place. It’s a gambling place, which fine, it has its place, right? But…

Dan Gray (59:56)
Mm-hmm.

Daniel Faloppa (1:00:13)
It doesn’t really bring forward much, I don’t think. At least compared to the promise that crypto can have in lowering transaction costs and increasing trust. Yeah.

Dan Gray (1:00:23)
Mm-hmm.

It’s funny to think about the parallel though. In a way crypto is incredibly transparent because you can see all the activity. There may not actually be much in terms of value or utility behind a token, but usually that’s there to see. You can understand that if you really care. It’s also very liquid, obviously. So think about that in terms of private companies. If you got to the point where private companies were

Daniel Faloppa (1:00:45)
Yeah, yeah, yeah, yeah.

Dan Gray (1:00:57)
required to be super transparent. So you always knew the latest valuation. You always knew the underlying metrics of that valuation. And if secondary markets were well established, it would be a lot more liquid as well. Do you then get a crypto problem though? Do you have an issue where startups begin to like game sentiment in the same way that you see in crypto markets to like pump their valuation?

Daniel Faloppa (1:01:11)
Yeah, and then it’s fantastic.

So when that chain that you described is tight enough, it works really, really well. For me, in crypto, that’s the case with Uniswap. Uniswap completely decentralized, like the whole governance is in code, the whole revenue is in code, the whole product is in code in that case. So you have complete traceability of the company metrics.

Dan Gray (1:01:25)
Mm-hmm.

Mm-hmm.

Daniel Faloppa (1:01:48)
So in that case, it works like fantastically well.

Anything else, like things like, and that’s why crypto products that do things for crypto, they are in crypto themselves and stuff like they work fairly well, like tether, so like stable coins, loans, interests on loans and stacking, like those types of things, they work fairly well. We haven’t had, like the moment you try to do something else, you more or less interface with…

Dan Gray (1:02:05)
Mm-hmm.

Daniel Faloppa (1:02:19)
the real world, you go out of the code word and you interface with the real world. And there haven’t enough legal linkages because you could say, this is revenue because we’re selling a physical product and our revenue gets in on crypto, right? But that link is not legally enforced by anybody. So if you at some point start putting investments instead of revenue, nobody can…

Nobody can verify that, right? Nobody can verify that you’re actually shipping those products, for example, nobody can verify that those receipts are actually customer receipts and not something else, And this is also on the capital. Nobody, like if you buy shares, nobody can verify those rights. Like now there are some structures in the US, but yeah. At that point, the thing breaks and then…

Dan Gray (1:02:46)
Mm-hmm.

Daniel Faloppa (1:03:12)
So you cannot do this type of good crypto companies that are not only only crypto. And that’s, think, the issue. And then, of course, it has also another massive problem. When you do do those type of things, you are a public company from day one, which has benefits, liquidity and potential of raising a lot more capital and so on.

Dan Gray (1:03:18)
Mm-hmm.

Daniel Faloppa (1:03:37)
but it also has incredible detriments of like you need to manage a community, you need to provide information, you need to build more in public. So if you’re doing something more differentiated or secretive, then you cannot do that. So there are advantages, there are disadvantages. Yeah, I think if we manage to, and that’s why I don’t, I think the crypto scene,

Dan Gray (1:03:56)
Interesting.

Daniel Faloppa (1:04:03)
dismisses the traditional scene so much that they throw away the baby with the bathwater. Some regulation you need to have, some way of getting back if there has really been a scam, some ways of, for example, retrieving the money with the legal system if you forgot the password. Some things are there for a reason. The difference between

between shares in a company and the products that the company has. And the difference between revenue and investment and the different accounting that you do of those things. It is very useful. It has been developed for a reason. It emerged. It hasn’t been developed. It emerged for a reason. And I tried to have some of these conversations with some crypto funds and it just went over the head. And I’m the one that doesn’t understand anything, which…

Dan Gray (1:04:48)
Mm-hmm.

you

Daniel Faloppa (1:04:59)
Might well be the case, but it would be nice to hear an argument other than you don’t understand the crypto world.

Dan Gray (1:05:09)
Yeah, I understand these things far less than you do. But, you know, I was watching Sam Lessin talk about a token he was involved in launching called Jelly Jelly. And he was talking about everything he’d learned as an investor in traditional companies getting into this crypto world and how to do a token launch in a fair and transparent way that has a good outcome for the company and for the for the users.

The problem being a lot of the time it’s a rug pull. The creators launch something and then the price shoots up and they sell at the top. And I was watching this thinking with my very basic understanding, I don’t understand why tokens don’t have a vesting period.

Daniel Faloppa (1:05:51)
Yeah,

Even IPOs, cannot, the management and the previous shareholders, they cannot sell the shares for six months. yeah. And on the other way around, the sort of the fundraising price ladder that you have in crypto, I think it’s a super interesting thing that you could replicate in startups. The reasons why you cannot do it in startups is because your transaction costs are insane.

Dan Gray (1:05:57)
Yeah, yeah, lockup. Yeah, exactly.

Daniel Faloppa (1:06:17)
So if every investor has a different incorporation act or a different price, you’re to, know, your cap table is going to look insane on day 0.5. And so you cannot really do it, but like that’s the magic that it can have, right? When you bring down transaction costs and you structure these things in code rather than impossible documents and things like that, you don’t have lawyers, you don’t have notaries for everything. You can, you can do so many more things that I don’t think we’re even scratching the surface of.

Dan Gray (1:06:17)
Mm-hmm.

Daniel Faloppa (1:06:47)
But yeah, there are lot of lessons that are very useful in traditional finance. Yeah, that’s a great example.

Dan Gray (1:06:55)
Interesting. Yeah, I feel like that’s a topic we should return to at some point. More about transparency and the offering that crypto has there,

We’ve got a couple more things. We’re getting towards the end. So we’ve been talking a little bit about the influence of how much money you raise and what the influence that has on your future growth and success. We’ve got like a longer read coming out about this fairly soon. But as a part of that, I’ve been looking at some of the existing literature. And it’s interesting that there’s a number of reports that demonstrate the, you know, in hindsight, maybe an obvious

observation that if you raise too much money too soon there’s a higher chance that your company will fail which is not not well discussed I think.

Daniel Faloppa (1:07:40)
Yeah, yeah, it’s not part of the conversation at all. We’re starting and we did a bit of that. do it in our workshops discussing what are the problems of a too high valuation. But even like we haven’t talked much about the actual lowering of your probability of success when you raise too much money or when you raise it to high valuation.

Dan Gray (1:08:06)
Mm hmm.

Yeah, a lot of our past writing about that topic has been like kind of theoretical. You know, you obviously may struggle then to reach the next fundraising milestone at an attractive price, you know, all these kind of things, it’s kind of obvious, but we haven’t thought so much or written so much until now about the reasons why it may directly lead to failure, which is

Daniel Faloppa (1:08:06)
So yeah, it’s interesting.

Dan Gray (1:08:29)
more or less in summary that you invest too much in growth before you’ve proven your core assumptions so when those assumptions don’t work out you now have a massive unsustainable chain around your neck you know there’s there’s very it’s very difficult to go back from that whereas if you haven’t invested that much it’s easier to to pivot and adjust

Daniel Faloppa (1:08:49)
Yeah, and there is data for this, right? That’s what this article showed.

Dan Gray (1:08:55)
Yeah, there’s a… Yeah, this is the Startup Genome Report on premature scaling, which outlines basically what I just talked about. There’s also this study, which is interesting, which looks at about 7,500 early-stage venture-backed startups from UAE over 22 years. And it shows a similar kind of conclusion, this U-shaped relationship of funds raised versus valuation, where…

Initially raising money does help grow your valuation, but eventually you get to the point where you’re over raising and actually it begins to hurt the company at that point.

Daniel Faloppa (1:09:30)
Yeah, interesting. And interestingly, it degrades also the valuation of that company at that time. So also this relationship that we see written a lot about, like your valuation is just like what the dilution that you can sustain times the amount of money that you need. Wrong. That’s U-shaped. If you want too much money, you’re going to have to give up proportional, even more equity.

Dan Gray (1:09:40)
Mm-hmm.

Mm-hmm.

Daniel Faloppa (1:10:02)
because you… Well, hopefully because investors know that you’re going to create this moral hazard, that you’re going to spend it on things that are not useful, or because you’re just going to have expectations that are too high and you’re going to have to start scaling prematurely like the Startup Genome article says, right? So, yeah, it’s something that we are getting more into, right? This idea that…

There is enough data now in the world in between what we do and like what others have done where we can start to do proper value-based investing, value-based understanding and value-based investing to an extent that is practically useful to returns and to success percentages of the companies. So hopefully there is a lot more to do in this, but hopefully we will.

Dan Gray (1:10:43)
Mm-hmm.

Daniel Faloppa (1:11:00)
Yeah, be a part of that discourse.

Dan Gray (1:11:02)
Yeah, and there’s a fair amount of existing perceptions that have to be undone in order to do that. I mean, we have a couple of posts to look at maybe quickly on that. You know, this is one by by Tom Tungus, a very well known and well regarded investor. And he’s talking about this auction mechanic for founders whereby they should aim, the best founders should aim to lower the cost of capital raise as much as they can as easily as they can, because they have this

capital as a competitive advantage at that point, which I think is thinking stuck in the like 2011 to 2021 period. And I don’t think it really makes sense as a long term sustainable strategy.

Daniel Faloppa (1:11:42)
Yeah.

Yeah. Yeah, think the… For some companies and for some markets and for some, know, like capital can be a competitive advantage, but that’s not what he writes about. And secondly, it’s not for everybody, right? So, for example, if you want to do this strategy in Europe, that’s the wrong strategy, right?

Dan Gray (1:12:11)
Mm-hmm.

Daniel Faloppa (1:12:11)
because you don’t have… Everybody can out raise you in the US or in the Middle East or Southeast Asia. So you shouldn’t… Pretty much any company that relies on this strategy in Europe probably should think twice. In the US, sure, you can execute this strategy to extreme success. See Uber.

That’s exactly what they did, right? Threw money at the problem and just got market share before everybody else. And arguably, they’re still in a lot of places competing with Lyft, but in a lot of places, they just developed that brand and they won the place, right? They won the city and the country and so on.

Dan Gray (1:12:43)
Mm-hmm.

Uber is a good example because it was clear that if Uber worked, it was going to be massive. Whereas applying this strategy to like the 17th B2B SaaS company that’s come out that quarter, it doesn’t work. I mean, it’s much less likely to work.

Daniel Faloppa (1:13:15)
Yeah, yeah. the interesting thing about Uber was that they were extremely clear about this. They knew that they wanted to use capital as a competitive advantage and they decided to bet on that and they were gathering data on that, like how sticky is a city, how much capital does it need to get to that sticky point where… So that can be a solid strategy, but first of all, it’s not the only strategy.

Dan Gray (1:13:44)
Mm-hmm.

Daniel Faloppa (1:13:44)
And

for some companies indeed, as we saw in the data, can be actually detrimental, lowering the chances of success. And I think that’s true for a lot of founders that for some reason find themselves in a very hyped position, maybe not of their own choice. And they do say yes, because the honey jar is too attractive. And then they find themselves in a difficult position.

Dan Gray (1:14:13)
Yeah, well,

on that we have the founder perspective here from from a guy who wrote about his company having their revenue cut in half due to it being built on top of WhatsApp and changes that WhatsApp made basically cut the revenue of the company in half. And he wrote this post regretting that he’d been offered money by investors and had turned it down. And that money would have been very useful, given what happened.

I think that this is a kind of a classic mistake that founders make is thinking that like venture capital is free money. Going back to what you said before, had he taken investment, he would have been pushed to immediately put that money into growth for the company. So then he would have had the same problem later on, exactly. Yeah. He would have lost half of more revenue and had investors that were, you know, vexed and on his back about fixing it.

Daniel Faloppa (1:14:58)
Just twice as big.

Dan Gray (1:15:09)
There’s a very good chance that would have killed the company completely, but as it is, I would say because he hasn’t raided money, he was able to turn it around. Like, that’s all that matters.

Daniel Faloppa (1:15:12)
They stayed more nimble. Yeah.

Yeah, they stayed more nimble, they

could pivot more easily, more like they were more agile. That’s an interesting point. And there is also this differentiation that like your like probability of winning is not the same as the outcome, right? So like, I guess as you highlighted, right, if you raise more capital,

Dan Gray (1:15:35)
Mm-hmm.

Daniel Faloppa (1:15:42)
you might not increase your probability of winning. And this outcome wasn’t affected at all by the amount of capital that they raised. Actually, it was completely independent on the amount of capital that they raised. If you raise capital, you are accelerating the current strategy. You don’t raise capital to do more pivots. It’s very, very rare that you might raise capital to do more pivots, but you don’t raise…

Dan Gray (1:16:02)
Mm-hmm.

Daniel Faloppa (1:16:10)
more capital, you know, like that initial, and that’s what we saw also in the other papers, early stages investments are fairly flat in terms of probability of growth afterwards, they are not connected. So if you raise more capital, what you increase, you increase the risk of just pre-committing before you can actually scale. And then in this case, it seems like he argues that

With more capital, they would have been faster. So they would have just gotten to the same conclusion, but in a bigger scale. He wouldn’t have raised to have more p-votes or to have a chance of more p-votes. So it’s interesting. The highlight for me is you need to think about your specific strategy and your specific issues and what you are raising capital for as well.

Dan Gray (1:16:43)
Mm-hmm.

Daniel Faloppa (1:17:07)
You need to have a certain safety net and chance to pivot, especially when your variability is higher, your risk is higher. So the higher your risk, the more safety net you should have, in a sense. And then as things get specialized, then you can raise more capital for your specific strategy and for scaling.

Like I think arguing one way or another, like blanket advice doesn’t do anybody any good.

Dan Gray (1:17:43)
Mm-hmm.

Yeah, it’s pretty much always unhelpful. As I say very regularly, startup success, those success stories are always, they’re outliers, so they’re by nature unlike anything else.

Daniel Faloppa (1:18:02)
Yeah, yeah. And that’s the difficult thing to appreciate, right? It’s like when you look at others, when you try to extract patterns, it’s difficult to at some point say, stop, we need to appreciate something different. But yeah, I mean, that’s the fun of it,

Dan Gray (1:18:21)
Yep, yeah, indeed. Well, I think we’ve gone for, what is it now? Almost two hours or hour and a half. One and half. There we go. Yeah, I think this issue of transparency and potentially the connection that has with crypto is really interesting. think we’ll revisit that. And certainly, I think we’re going to revisit this question of pricing versus valuing.

Daniel Faloppa (1:18:27)
One and a half.

Dan Gray (1:18:44)
venture capital as a value investing discipline. I think it is definitely worth spending a bit more time on as well. So next time we come back, I guess we’ll be getting stuck into one of those.

Daniel Faloppa (1:18:54)
Yeah, it’s time to have those conversations.

Dan Gray (1:18:57)
Yeah, I think so. All right. Thank you very much, Daniel.

Daniel Faloppa (1:18:59)
Thanks everybody, thank you.