2024 VC trends, portfolio construction, & more with Churchill’s Raja Doddala | E1914

Jason welcomes Churchill Asset Management’s Raja Doddala to the show (00:00:00)

• Cash invested in pre-seed and seed at a 13 quarter low
• Number of deals has decreased
• Venture capital market returning to normal after a period of excessive investment
• LPS and managers forgot about the J curve and overspent
• Danger of excessive investment in venture capital
• Historical pattern of excitement leading to overspending
• Discussion about Churchill Asset Management
• Focus on VC world, exits, and capital deployment
• Raja Doddala runs Venture and growth at Churchill Asset Management
• Discussion about VC world, exits, and capital deployment

Trends in pre-seed and seed deal values (00:01:52)

• The number of AI deals in 2023 has decreased compared to 2021 and 2022 but remains higher than the average of 3,000 deals per year.
• The deal value has also decreased from its peak of almost $100 billion per quarter to around $40 billion per quarter.
• Pre-seed and seed deal value and the number of deals significantly decreased in Q4 of 2023.
• Despite the decrease in deal count, valuations for seed and pre-seed investments remain high, even surpassing those of 2021 and 2022.
• The median pre-seed deal size has remained consistent since 2022, while the 75th percentile has reached $1.5 million.
• Seed deal sizes have also increased, with the 75th percentile reaching $5 million, which is typically considered Series A territory.

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Competitiveness and predictability in pre-seed, seed, and series A (00:10:40)

• Pre-seed funding now requires a product demo and possibly beta testing, and friends and family rounds are considered pre-seed instead of angel rounds.
• Seed funding requires paying customers and evidence of product usage and engagement, and investors are looking for customer cohorts and predictable customer segments.
• Pre-seed valuations are low single digits, seed valuations can reach high single digits with three customers, and predictable year-over-year growth can lead to an 8-figure valuation.
• Churchill Capital allocates 55-60% of its committed dollars to Series A through D investments and selects a concentrated group of 8-10 managers for these investments.
• Churchill Capital also invests in 20-25 smaller managers for pre-seed and seed investments, with fund sizes ranging from $25 million to $110 million.
• Churchill Capital typically invests 5-15% of a fund's total size, with investments ranging from $2.5 million to $3 million for a $25 million fund.
• Churchill Capital allocates around 35-40% of its capital to seed and pre-seed investments and likes to layer in additional capital in outliers through co-investments post-product market fit.
• Churchill Capital identifies companies in the seed stage that its Series A funds invest in and then makes additional investments in those companies when they reach Series C or D.

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Trends in exit values (00:22:46)

• The total exit values in 2023 significantly decreased compared to 2021 but were comparable to levels seen between 2013 and 2015.
• 87% of all exits in the past decade have been valued below $100 million, demonstrating the power law distribution in venture capital returns.
• To achieve a 3x DPI net in 10 years, a $1 billion venture capital fund needs to generate approximately $4 billion in exit value, which is challenging given historical stock market returns.
• A strategy of investing $20 million in 50 companies with a diluted ownership of 10% can help a $1 billion fund reach its target exit value and achieve a 14-15% IRR.
• In the past decade, there have been few exits exceeding $10 billion in the venture market.
• Smaller firms with $100 million funds can still achieve a 3x net return without requiring a billion-dollar exit.
• Owning an average of 5% at exit can yield substantial returns, even without reaching a billion-dollar exit.

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Exploring portfolio architecture and the difference between mega funds and smaller funds (00:30:24)

• Venture capital exits peaked in 2021 with $2 trillion in value and 2,000 exits, but have since declined due to a drop in seed and pre-seed stage exits.
• "Aqua hires" occur when a large tech company acquires a startup primarily for its talent, often resulting in a low return for investors compared to the founders and preferred staff.
• The return of Republicans to office could potentially lead to a more favorable environment for mergers and acquisitions (M&A), which have been hindered by anti-capitalistic approaches.
• Balancing market competitiveness and allowing M&A is a challenge, as overly restrictive regulations can hinder innovation and growth.
• Mega funds are for investors seeking absolute dollar returns and are not focused on achieving high multiples, while smaller funds, such as seed and pre-seed funds, are suitable for investors targeting higher multiples (3x to 5x net).
• Seed funds typically invest in 100 companies with the hope of finding a unicorn, but they often lack reserves for follow-on investments.
• Venture capitalist Raja Doddala recommends having reserves to make second and third bets on successful investments, as most of a company's value is created in the last 18 months before exit.
• Doddala emphasizes the importance of understanding public market comps as a private market investor and actively trading a portion of one's portfolio to gain a better understanding of public market dynamics.
• The decision to hold or distribute shares in public companies resulting from exits depends on the specific LP base and their preferences.

Prospects in the vc over the next few years and the rise of the next generation (00:50:59)

• AI technology advancements suggest a promising future for venture capital, with pent-up demand for IPOs and M&A indicating potential liquidity.
• While there may be initial overestimation of AI's short-term impact, its current use by incumbents to improve products and distribution could lead to significant value creation in 2-4 years.
• Early-stage funds with high median entry prices may face challenges if their companies are overtaken by newer technologies, emphasizing the importance of time dispersion and pacing investments.
• Time diversification is crucial in venture capital to capture economic cycles, technology maturation, and incumbent changes.
• Seed-stage funds should be evaluated based on entry prices, questions asked during fundraising, and reasons for writing checks, with a focus on investing in a large number of companies and meaningfully investing in the top performers.
• Successful venture capital funds like Coast and Dallas Venture Capital demonstrate the importance of disciplined entry prices, sector focus, and a clear path to top quartile returns.

The role of secondary sales in venture capital and importance of liquidity for VC funds (00:59:26)

• Founders often approach general partners (GPs) to sell a portion of their shares, typically around 10-20%, to provide liquidity for limited partners (LPs) and themselves, shorten the J-curve, and act as a form of "idiot insurance" in case the company's value declines.
• GPs should encourage portfolio companies to consider liquidity and set expectations with founders regarding selling shares, but avoid being overly prescriptive in how they manage their liquidity.
• Despite concerns about disappointing investors, founders are initiating discussions about selling a portion of their positions in the current market, which can provide them with financial security and encourage them to stay committed to the company or start new ventures.
• Raja Doddala, from Churchill Asset Management, emphasizes the importance of understanding the underlying fundamentals of a company before investing, as well as diversification and risk management in portfolio construction.
• Doddala believes that the current market environment presents opportunities for investors to find value in the venture capital (VC) space.