Perfect Storms & Inception Stage Capital

Now is the time to disrupt venture

TLDR: We are in the perfect storm for disrupting venture and building the best inception stage fund on the planet.

It seems this year, more than prior years, I’ve been writing Monday Morning Meeting on a flight or from an airport lounge.

That’s probably because we’re front-loading our time so we can win the long-term game.

LGA to BOS this morning to meet more LP’s, and it’s a weird financial climate.

It seems everyone agrees that this is the single greatest time in history to be investing in technology.

But at the same time, human beings are impatient for progress and long-term asset classes require a special level of foresight, conviction, and mathematical reasoning.

Interestingly, the stratification we’re seeing in technology continues to intensify too.

In the public markets, the Nasdaq is up 38% over the last 12 months, but of the 8.4T in value, 5.3T is the top six - Apple, MSFT, Google, Meta, Amazon, NVIDIA.

The same thing is happening in venture, with the top venture firms accruing most of the LP capital into their funds, and most of their investment decisions accruing into AI and the mega deals in their portfolios with ~40% of the $79.2B invested in 2024 being driven by AI.

But to further make the point on stratification, not only are funding levels rising again after a three-year decline, but it’s happening at a time when the number of active venture funds as shrunk around 60%, from ~24,000 down to around ~10,000.

Capital is being concentrated into the mega firms, into the mega deals, and into AI.

Overall, I think LP’s focusing their venture allocations, which is typically 10-20% of their portfolio, into the mega funds without hedging it with a rising challenger fund that can produce outsized returns is just insanity.

Of course, these mega funds are legendary investors with legendary track records, but the math is just making less and less sense to concentrate into them.

• Mega funds will continue to regress to 2X return profiles which is similar to the public markets over 7-10 years; it’s just too much capital for the 10-year time horizon of the fund

• Most of the great venture-backed IPO’s were 12-15 years in the making, and the public markets have doubled investor money every 7.2 years on average; so you need at least a 3X over 10 years or 5X over 15 to make it reasonably worth it—both are exceedingly rare with recent top quartile funds only achieving ~1.6X

• And to make matters worse, the mega firms are now all charging 3-3.5% management fees and 30-48% carry—completely insane on fund sizes in the billions; you neither need that much management fee cash to operate, nor can you justify a 10-20% premium on carry when you’re very unlikely to beat the public markets

• As average check sizes go up, so do valuations, which eliminates the tax advantage you often see in venture. Most of this capital goes into growth stages and isn’t deployed into sub-$50m valuations where QSBS would allow a majority of gains to be tax-free, so LP’s are losing advantages of VC investing on both sides of the equation

• Of course, it is possible that these funds may back the next trillion-dollar company and hold it for longer than a typical fund life. In those top six juggernauts I mentioned, they all accrued 99% of their value post IPO; just imagine if those venture funds had held these positions for 30 years or more. Returns would be astronomical — that likely means we’ll see those mega funds become crossover funds; at minimum they will have to extend fund lives beyond 10 years to realize enough value to return the billions they’ve raised and deployed

• Compounding the problem is this same stratification and accrual of value means that incumbent tech players will have major cash positions to acquire competition; M&A will continue to rip with IPO markets frozen meaning the returns from Power Law these VC’s were modeling may not be what they hoped; take Stripe offering $1.1B last week to acquire Bridge for example. That’s a big exit, but it’s not iconic. Owning 20% only returns $200m; with Sequoia writing that check out of a multi-billion dollar fund, they’re not even getting a 1X from this outlier. Of course, it will still be ~$150m of returns within 24 months after closing and distributions are all finalized, which is an astronomical IRR on their $50m investment. It’s just not the $80B Stripe competitor that would make the investment and the subsequent returns of a single investment iconic

• In order to deploy this much capital, VC’s need to write massive checks and go for $100B - $1T outcomes; and that’s why a vast majority of this funding is going to foundational model companies like OpenAI, Anthropic, Cohere, Mistral, etc because those are expensive businesses to operate that can both consume a ton of cash and accrue a ton of enterprise value (ie OpenAI at 150B+ valuation); meanwhile inception stage AI companies are generating cash and profitability faster than ever and need less VC money than ever. This is putting these new business models, at least in part, at odds with the demands of a mega fund’s charter to deploy vast amounts of money

So how do you find alpha in this market? How do you create 10X or 100X funds?

I think you need to play the opposite game of the mega funds, and the opposite game of the LP’s who despite their agreement that this is the most exciting time in history to back inception stage companies, really aren’t putting their money there... yet.

So what’s the opposite?

• Lower valuations instead of higher. Don’t compete on price, compete execution

• Invest earlier. The average accelerator company is 14 months from incorporation and the average priced round for a seed company happens at 38 months. Backing founders at a stage that no one else will both upstreams the deal flow for the fat part of the early stage market while producing more great companies for the Series A funds who have the concentrated capital and the need to deploy. As Clayton Christensen explains in The Innovator’s Dilemma, to disrupt a market you need to focus earlier in the lifecycle and supply chain, where others aren’t willing to, and innovate from the bottom up

• More ownership with less long-term dilution. AI-native companies have tremendous leverage over incumbents, are far more capital efficient, and are insanely fast to profitability. Less capital needed in the future means less dilution too

• More hard problems, more deep tech bets. Deep tech wasn’t historically sexy to VC’s because it took forever and risk was near infinite. That’s not really the case anymore. Deep tech companies are moving faster, commercializing sooner, upside can be 20-100X that of a traditional software company, and funds are extending to 15+ years making the time horizons align for the first time in VC history

• Write larger inception stage checks. From friends & family rounds up to accelerators and pre-seed funds, the typical commitment is 100K - 500K to get a company going. The higher end of this range means founders can skip over those faux seed rounds that are highly dilutive, and instead, go straight to raising a true $3-5m seed

• Build an opportunity fund. At a time when opportunity funds are shrinking, from 120 and $12B down to 30 funds with $3.5B, inception funds should start doubling down on the best companies before a seed fund has the chance, and take high conviction swings to maximize Power Law

I strongly believe that in order to win, we need to be different to be better. We need to be right when others are wrong.

In every instance of pure play venture capital, there is an asymmetric counterpoint to be exploited. Most venture firms, like the large tech giant incumbents, aren’t nimble enough to adapt. They have built massive and bloated firms with massive and bloated fee structures that aim to give LP’s returns that are just slightly above market, and rarely worth the illiquidity they create.

It’s time for a changing of the guard.

In the early days of VC, we had 10X-100X funds that made venture wildly exciting.

Benchmark I for example.

And we had funds like these because there was a differentiation created in the value of the capital. There was a supply & demand curve being fixed.

The same is true today.

There is only one firm in the world upstreaming the acceleration funds and truly backing inception stage.

There is only one firm in the world truly backing execution.

And on top of it all, the math is just undeniable because of how mispriced inception stage financing is.

While this post may be somewhat of an unfinished thought, it’s a download of what I think is making for the perfect timing to build the best inception stage fund on the planet:

• Great founders

• Great technology

• Undifferentiated incumbents

• Stratification in supply & demand of companies and funders

• Stratification in the value of companies and checks being written

• A truly mathematical approach to generating top decile returns and outperformance

Unfortunately, that’s all we have time for on a puddle jumper from NYC to Boston at 7am.

Have a great week.

See you Monday.