When venture incentives and founder needs diverge
"Are you a firm that's looking to optimize the 2% or optimize the 20%?"
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When venture incentives and founder needs diverge
The other day I invited Altimeter’s Jamin Ball to come on TWiST. His recent essay on venture incentives, and how their alignment with founders is getting out of sync due to rising AUM and the power of fees, was super interesting.
The whole chat is, I hope, worth your time, but I’ve pulled out the key piece from Ball that details how VCs can get rich today off 2% fund AUM charges, instead of needing the same exits that founders do to make their daily bread (off a 20% share of returns). Or as he puts it: are you building a 2% fund, focused on raking in income risk-free, or a 20% fund, looking to make your real income off of exits?
Here’s Ball (transcript very lightly tidied up), digging into how ever-larger venture funds can wind up high on their own (capital) supply:
There's now an easy button to get rich, which is raise as much money as possible, and you can get rich off that 2% fee. That's not to say you can't get rich off the [20%] carry. You certainly still can. I mean, the numbers are still huge. But there is a path to getting rich [as a venture capitalist] where the outcome of the underlying companies in a fund don't matter, and it's guaranteed.
I would say it's economically rational to go maximize the guaranteed portion of your income stream versus the harder, variable portion. And so what does that lead to? It leads to — what we talk about is — are you a 2% firm or a 20% firm, right? Are you a firm that's looking to optimize the 2% or optimize the 20%?
And that's where the incentive alignment matters. Because it's not to say that investors and founders now have opposite incentives, right? It's not like your failure leads to my success and their perverse incentives. It's just to call out the outcome [can be] irrelevant [to VCs getting rich of high-AUM fees that are not performance-based]. And now it's, how can I maximize my AUM? How can I maximize my deployed dollars?
But that part of it can lead to suboptimal outcomes and experiences for founders who are offered too much money at too high of a valuation, which is obviously negative.
This explains much in terms of why some early stage rounds are so large. A big fund might be happy to overpay for a Series B, for example, if it means deploying more capital. Why? Because more deployed capital means a smaller window between funds. And if you can deploy and raise another fund quickly, you can greatly expand your firm’s cash flow by adding another chunk of AUM to carve 2% off of yearly.
Funnily enough, CO got close to detailing this dynamic back in May, when we wrote in the second edition of this newsletter that we’d sorted out why some crypto rounds were so big. Discussing the then-recent Farcaster mega-raise, we wrote:
But if Farcaster is still small in user and employee terms, why did it raise so much? Or more precisely, why was there so much venture capital demand for its shares at this stage? Two reasons:
The number of consumer-facing crypto apps that could transcend the casino segment of web3 is not very large; this concentrates venture demand for shares in the crypto shops that could help take blockchain technology mainstream.
The amount of cash looking to invest in winning web3 deals is pretty damn large; this means that when an attractive bet comes along, there is pressure to get as much capital into the deal as possible.
That latter bit is more than a little related to what Ball is describing.
What’s your book worth?
404 Media broke the news this week that Harper Collins, a major publisher, is working with a tech company — now revealed to be Microsoft — to ingest backlist titles into its datasets for a new AI model. The proposal? According one author who shared screenshots of what he described as an offer in the scheme, it works out $2,500 per book for a three-year deal.
Daniel Kibblesmith, the author who posted the offered terms on Bluesky, declined. And when asked what price he’d be willing to accept, he responded that he’d “probably do it for a billion dollars.” Why that sum? Taking the deal would only make sense, Kibblesmith posted on Bluesky, “for an amount of money that wouldn’t require me to work anymore, since that’s the end goal of this technology.”
On one hand: good on tech companies offering to pay for copyright-protected media and on Harper Collins for keeping the program opt-in instead of opt-out. On the other: $2,500 to help train a machine to potentially replace you is minimal.
All eyes on Nvidia
It’s a big earnings day in technology. Most of the attention will be consumed by whatever Nvidia will report after the bell. Analysts expect $33.2 billion worth of top line and net income of $17.43 billion. In year-over-year terms, the WSJ notes that the street expects Nvidia’s revenue to “nearly double.” (Nvida is dueling with Apple for the title of the most valuable company in the world, recall.)
Nvidia posted net income of $9.24 billion in the year-ago quarter, for reference.
But the chip giant is not the only tech company of note reporting today. Expect numbers from Palo Alto Networks (+34% YTD), Wix (+56% YTD), and Nio (-45% YTD). And if you need even more Chinese EV earnings news, here’s Xpeng’s Q3 result set.
Tomorrow: Notes from Nvidia’s earnings call, and the best definition of ‘founder mode’ I’ve ever read.