Venture when markets are down, cheating with AI and natural history

The market is down. What does this mean for venture?

Yes, the market is down, relative to historical highs… But those highs were likely irrational, argues Joe Lonsdale, in this excellent piece. “What happened? Essentially, it was euphoria. In the 2021 environment, technology investing had worked well for years and many argued that the valuation for exciting but hard-to-value businesses ought to be higher, reflecting two decades of investment success. Accordingly, investors propelled by lots of liquidity rode this market trend. With a few notable exceptions, the businesses that got funded — especially in the growth stage — were showing serious growth, high margins, and the potential to grow for years into eventually generating large cash flows. But their valuations were still extremely high compared to how markets historically value businesses, even in software. By way of example: Peloton — a business with a great product that I use — peaked at a market cap of $60 billion, nearly 60 times the company’s year-forward gross profit.”

Does this mean venture returns will face headwinds going forward? No. It will be a better time to build businesses. “Talent is more accessible. Today, due to a number of factors, partnering with top talent isn’t as expensive.  Overfunded companies in the past decade that arbitrarily bid up the value of engineers are today laying them off, or slowing hiring…Less money will be wasted on zero-sum spend. When venture dollars are in oversupply, advertising channels become filled with noise, and it’s very expensive to be heard and seen.”

Who will the winners be? The world of venture is being shaken up. On the one hand, larger platforms are becoming larger. Emerging managers are increasing the long-tail. And new entrants like crossovers and corporates are part of the community.

One answer: when public markets experience volatility, returns belong in emerging managers: “Brand-name growth funds may dominate the headlines, but an industry secret is that the best return profile in venture capital has historically been produced by the newcomers and at the early stages of investing.” The data would support this. “Data from Cambridge Associates shows that new and developing firms are consistently among the top 10 performers in the asset class, accounting for 72% of the top returning firms between 2004–2016.”

As Sebastian Mallaby argued in this month’s deep dive, the future leaders in venture capital will have unique strategies in industries or geographies, and strong embeddedness in their ecosystems.

What do you think?

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What’s happening with remote work?

In Out-Innovate I wrote about two related trends in global innovation: startups were increasingly born global and distributed. Born global means they are multi-market from the get go in their sales. Distributed means the team does not have a single concentration, and can itself also be multi-market. Sometimes startups can both be born global and distributed.

The pandemic has proven both out, but most of all, with distributed teams. The shift is so profound that some investors explain that today “Silicon Valley is being unbundled.” This is less a comment about Silicon Valley the place, but more a reflection on the innovation industry. “If you were building a startup five, 10 or certainly 15 years ago, most of the work in focus was very local, meaning you were what we call ‘default local.’ You’d have a group of people that would get together in a physical office and toil away to build a software product and sell it to customers that were probably in your country — maybe even in your neighborhood if you’re in Silicon Valley — but certainly in your country. And then over time, if the product and company was successful, you would slowly expand globally…The idea now is that the company of the future, and the company of the present, will be global on Day One and the opportunity…is to build all the infrastructure for that company to be able to operate and sell globally on Day One.”

The news is of course not new (we’ve been covering this story for two years here for example), but it is certainly truer than ever before.

This shift is having real impact around the world.

Alec Stapp @AlecStapp

Biggest permanent change due to the pandemic is remote work: Office occupancy still down by more than 50% (!) and the return to office trend is starting to plateau

And yet, this doesn’t mean everything is remote.

Human connection matters. It matters for building ideas and it matters for venture.

The average venture relationship is longer than the average American marriage. And it is harder to unwind. Invest the time to get to know the other side.

Figuring out best practice will still take time. “History shows that mixing virtual and on-site working might be a lot harder than it looks—despite its success during the pandemic.” There are real possible downsides to remote work. “These downsides arise from the organizational norms that underpin culture and performance—ways of working, as well as standards of behavior and interaction—that help create a common culture, generate social cohesion, and build shared trust. To lose sight of them during a significant shift to virtual-working arrangements is to risk an erosion over the long term of the very trust, cohesion, and shared culture that often helps remote working and virtual collaboration to be effective in the short term.”

That’s why Silicon Valley is not dead. Agglomeration of talent and capital still have value. But it is also why other ecosystems around the world will become increasingly dominant forces in the world of innovation - and startup success will increasingly become multi-polar.

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Interesting discussions

What is cheating with artificial intelligence? An A.I. generated picture won an art contest. Many are upset. Artificial intelligence has already dominated chess. Yet tech-enabled cheating is now at the center of a major controversy at the highest levels of the game. And A.I. is coming to help with your kids homework. Is that ok? AI will also come to automate many more aspects of our lives, and we’ll need to contend with the same question.

Amazing to watch the rise and fall of the top websites on the internet. Notable for me are two trends: 1) how many of these sites are global and 2) relatedly how compartmentalized the internet seemed.

Some of these top sites have seen constant reinvention. Some haven’t. Fascinating piece in the history of Craigslist and why it (still) looks the way it does. Short answer why: “Because that serves people better. I've learned that people want stuff that is simple and fast and gets the job done. People don't need fancy stuff. Sometimes you just want to get through the day.”

In many emerging ecosystems I’ve argued that the best startups are creators rather than disruptors, building real solutions for real people. Good piece with tactical examples of startups serving underserved communities in a range of industries. “When technology connects the world’s population, what initially seem like small markets can reveal themselves to be much larger than expected. But tech is also built disproportionately for certain groups; there are many communities that are underserved, or whose pain-points are less visible and therefore less addressed by technology companies. These gaps form opportunities for startups.”

My first role in venture was with the Omidyar Network, a pioneering impact investor as well as the family office, venture fund and philanthropy of Pierre (the co-founder of eBay) and Pam Omidyar. Because tech news is often dominated by stories of Google, Facebook, Amazon or Tesla, it is easy to overlook the incredible impact eBay has had on the internet. “eBay was one of the first big internet companies. It became profitable early, grew into a giant of the dot-com era, survived the implosion of the dot-com bubble, and still ranks among the largest e-commerce firms in the world. But what makes eBay particularly interesting is how, in its earliest incarnation, it anticipated many of the key features that would later define the phenomenon commonly known as the ‘platform’. eBay wasn’t just a place where collectors waged late-night bidding wars over rare Beanie Babies. In retrospect, it also turned out to be a critical hinge in the history of the internet.”

What can Silicon Valley’s history teach us about the future of venture capital? I dove in this month. Read it here.

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Book of the month

Albert Einstein once said ““If you want to know the future, look at the past.”

So what will happen to earth if humanity doesn’t get its act together on climate change? I learned one perspective this month from A Natural History of the Future: What the Laws of Biology Tell Us about the Destiny of the Human Species.

As the NY Times reviews it: “Levees surround us. Yes, some hold back rivers that strain against their embankments. But others hold back diseases, which are ready to saturate and overwhelm the fragile walls of antibiotics we’ve erected. And sometimes levees fail. The metaphor extends beyond epidemiology. Nature ceaselessly advances, trespasses, embarrasses our every effort to keep it at bay, and ultimately bursts through. Its rivers will not be contained.”

And as we change nature, so are we changing our own habitat. “While it might not surprise us to read that mosquitoes have a niche that affects their distribution on the planet, it might be more difficult to recognize that we humans do as well. We are animals after all, and can be studied as such by ecologists. Even with the spread of air-conditioning, and all the creature comforts afforded by burning fossil fuels by the gigaton, we still mostly inhabit the same shockingly narrow band of the globe that we have for millenniums. But as we push the climate beyond the norms of the past three million years we will hit the hard limits of physiology. And as the familiar rhythms of the seasons grow more syncopated and strange, some swath of our range will be increasingly foreclosed, to God knows what geopolitical effect.”

To this depressing reality, I share my monthly read.