Tomasz Tunguz and David Clark on how to invest in AI and Q1 2024 startup valuations | E1930

David Weisburd intros David Clark, Tomasz Tunguz, and Jason Calacanis (00:00:00)

• David Weisburd introduces the guests for the podcast: David Clark from VCAP, Tomasz Tunguz from Theory Ventures, and Jason Calacanis from the Launch Fund.
• The podcast is sponsored by Squarespace, OpenPhone, and CLA Innovation.
• YC had its demo day last week, and the data on the new class is out.
• There are already several breakouts from the new YC class.
• The hosts discuss startup valuations for Q1 2024.
• David Clark from VCAP:
  • Invested in:
  • A company that is building a new type of database.
  • A company that is developing a new way to treat cancer.
• Tomasz Tunguz from Theory Ventures:
  • Invested in:
  • A company that is building a new type of chip.
  • A company that is developing a new way to store data.
• Jason Calacanis from the Launch Fund:
  • Invested in:
  • A company that is building a new type of social network.
  • A company that is developing a new way to learn.

The latest YC class and rise of AI startups (00:01:59)

• Gary Tan's winter incubator program accepted less than 1% of 27,000 applicants, focusing on AI companies.
• AI opportunities include co-pilots for autocomplete and agents that act on users' behalf, with the potential to replace workers in data processing and customization tasks.
• Startups are prioritizing practical and verticalized AI to compete in areas where large companies lack attention or have unique data sets.
• The hardware stack for AI is unlikely to be dominated by startups due to capital intensity, while large language models may become commoditized, raising valuation concerns.
• Startups are likely to adopt cost-effective open-source AI solutions, and verticalized applications that combine AI with other features can enhance user engagement and retention.
• Enterprises are sampling AI products but face challenges in ensuring accuracy, usefulness, and transitioning from intriguing to essential.
• The AI industry may experience a "trough of disillusionment" before realizing its full potential.
• YC's acceptance rate is approximately 1%, with around 260 startups in recent classes, and aims to fund 500 startups annually.
• The success of AI startups depends on creating compelling products that enterprises will continue to use beyond pilot programs.

Tomasz Tunguz and David Clark on how to invest in AI and Q1 2024 startup valuations | E1930 (00:00:00)

• Tomasz Tunguz and David Clark discuss investing in AI and startup valuations in Q1 2024.
• AI is a transformative technology with the potential to revolutionize various industries.
• Investing in AI startups can be lucrative, but it requires careful consideration and understanding of the technology and market landscape.
• Market Research: Thoroughly research the AI market, including industry trends, competitors, and potential applications.
• Technical Expertise: Assess the technical capabilities and expertise of the AI startup's team.
• Data Access: Evaluate the startup's access to relevant and high-quality data for training and improving AI models.
• Scalability: Consider the scalability of the AI solution and its potential for growth and expansion.
• Ethical Considerations: Be mindful of ethical implications and potential biases in AI systems.
• Startup valuations in Q1 2024 are expected to be lower compared to previous quarters due to economic uncertainties and market corrections.
• Investors are becoming more cautious and conducting more thorough due diligence before making investment decisions.
• Startups with strong fundamentals, clear business models, and sustainable growth potential are likely to attract investment despite the challenging market conditions.
• Founders should focus on building a strong team, developing a clear and compelling business plan, and demonstrating traction and growth.
• Be prepared to adapt and pivot based on market feedback and changing conditions.
• Emphasize the long-term value and potential of the startup rather than relying solely on short-term metrics.
• Investing in AI startups requires careful consideration and a deep understanding of the technology and market landscape.
• Founders should focus on building strong fundamentals and demonstrating sustainable growth potential to attract investment in challenging market conditions.

Role of the founding team in AI startups (00:10:55)

• The AI market is rapidly evolving, and successful companies will adapt quickly and avoid becoming dogmatic.
• Distribution is crucial, as customer acquisition costs rise, so companies that can build products with a customer acquisition advantage will thrive.
• It's still early in the AI shift, but there's potential for significant franchises, and venture firms should invest in this area.
• Over time, exceptional AI-native managers may emerge, leading to disruption at both company and venture firm levels.
• Tomasz Tunguz and David Clark emphasize the importance of identifying great technical teams with product velocity and customer understanding when investing in AI.
• Tomasz Tunguz focuses on seed-stage investments of $500k to $2 million in teams with a product in the market and some customers.
• David Clark's firm conducts thorough research to grasp the challenges and opportunities in the AI market.
• Both investors stress the need for robust security measures and clear processes for onboarding and managing AI agents within organizations.

Startup valuations and the changing landscape of seed deals and Series A rounds (00:19:34)

• High startup valuations, particularly in the late stage, may not be sustainable due to depressed exit valuations and regulatory issues affecting big tech companies like Google, Facebook, Microsoft, and Apple.
• Entry prices for startups have increased significantly, with Series A rounds now valued at $30-40 million compared to $12-20 million in the past, squeezing returns for venture capitalists.
• Some AI companies are being priced similarly to how startups were valued during the peak of the zero-interest-rate environment in 2021, despite having low revenue.
• The outcome of the upcoming US election could impact the M&A environment and regulatory landscape for tech companies.
• Venture capitalists should remain disciplined and maintain a three-year investment period to mitigate risks associated with high valuations.
• Tomasz Tunguz and David Clark discuss investing in AI and startup valuations in Q1 2024.

OpenPhone - Get 20% off your first six months (00:29:01)

• OpenPhone is a business phone app that simplifies business communications.
• It offers features such as shared phone numbers, multiple employees fielding calls and texts, and instant replies.
• OpenPhone is rated number one for customer satisfaction on G2.
• Twist listeners can get an extra 20% off any plan for the first 6 months at openphone.com/Twist.
• OpenPhone can port existing numbers from other services at no extra cost.

Tomasz Tunguz’s journey to raising his fund and the challenges of the VC industry (00:30:17)

• Tomasz Tunguz and David Clark discuss investing in AI and startup valuations in Q1 2024.
• It's advisable to take the full 36 months for primary deployment rather than shortening it to 18-24 months.
• Finding outliers is challenging, and even a $500 million fund needs to find a decacorn.
• Tomasz Tunguz's fund will have 15 concentrated portfolio shots on goal, focusing on ownership.
• Two dominant strategies emerge: a broad index with a later-stage concentration vehicle and a highly concentrated fund with significant ownership and modeled exit valuation.
• Tomasz Tunguz, a former managing director at Redpoint for eight years, raised $238 million in four and a half months for his fund, which closed in March 2023.
• The fund faced challenges during the Silicon Valley Bank implosion, as limited partners (LPs) hesitated to wire funds due to uncertainty.
• David Clark highlights the concerning number of venture capital (VC) firms in the market, with 6,500 VC funds seeking to raise capital, leading to a high failure rate for funds reaching their second fund.
• Venture tourism, where managers fail to raise a second fund, poses a significant risk for LPs who invest in these funds.
• LPs should carefully assess the long-term commitment and viability of venture fund managers before investing, as the venture capital industry requires a 15-20 year timeframe for full realization.
• According to Pitchbook estimates, over 247 first-time managers who closed funds between 2019 and 2021 will not be able to raise sophomore funds, creating a challenging environment for LPs who invested in these funds.

Personality types in venture capital and handling company wind downs (00:37:32)

• Some board members change when a company raises a new fund or the senior partners decide to retire.
• First-time funds usually don't have board seats, so they have less responsibility to oversee the portfolio.

CLA - Get started with CLA's CPAs, consultants, and wealth advisors now (00:39:20)

• CLA provides CPA, tax consulting, and wealth advisory services to startups.
• CLA works with startups from seed round or Series A to multinational entities with complex tax structures.
• CLA can also assist founders with wealth management after the exit.

VC’s moving out and the challenge of picking the right company to invest in (00:40:52)

• The venture capital (VC) industry is experiencing significant changes, with senior partners stepping aside and attrition at junior levels, leading to challenges in managing succession and delivering bad news to founders.
• The hiring process for researchers and analysts involves meeting numerous companies before making investment decisions, requiring a specific personality type that can handle challenges and make tough decisions.
• There are two main personality types in venture capital: optimistic grinders with extensive networking skills and those who rely on their industry expertise and personal connections.
• Despite the challenges, VCs must maintain a positive outlook while having difficult conversations with founders.
• The oversaturation of VC firms in the market has led to inefficiencies, and a concentrated portfolio focusing on successful founders can be easier to manage.
• Founders should be prepared for potential investment losses and build relationships for future opportunities, while investors should accept losses and understand the risks involved.
• Investors should select disciplined managers who have successfully backed top-performing companies multiple times, examining their decision-making processes and addressing structural issues in case of poor performance.
• Venture firms experience ups and downs, and their ability to navigate challenging times leads to sustainable success.

Active reserves management (00:59:27)

• Tomasz Tunguz and David Clark discuss investing in AI and startup valuations in Q1 2024.
• Redpoint employs various strategies to enhance the investment process, including structured votes, quantitative research, and probabilistic scenarios for each company.
• Active management of reserves is crucial for fund performance, as it allows VCs to reduce exposure to loss-making companies and increase exposure to high-performing ones.
• The rise of separate growth vehicles has led to reduced reserves in early-stage funds, as companies are staying private for longer.
• Stripe is considered one of the most valuable private companies globally, surpassing companies like Edan and possibly even Saudi Aramco.
• Effective reserve strategy management is essential for successful VC firms, with some successful firms adopting aggressive strategies like 70-30 or even 80-20.
• Clear communication with portfolio companies regarding reserve strategies is crucial to avoid misunderstandings and disappointment.

Lightning round: Top 3 investments (01:09:00)

• Tomasz Tunguz's top investment picks include Mother Duck, an open-source database company, Omni, a business intelligence tool, and Arbitrum, a Web3 company that processes more transactions than Ethereum.
• David Clark's interesting investments include Newcomer, a language learning platform through video games, Recall, a browser extension that acts as a personal knowledge repository, and Pod Engine, which indexes podcasts and allows users to track and search specific topics.
• Tomasz Tunguz and David Clark discussed investing in AI and startup valuations in Q1 2024 on the Liquidity Podcast.
• They mentioned an established manager who was an early investor in a prominent social media company in the 2000s and made successful hardware deals.
• David Clark prefers to invest in firms with a history of identifying top 1% companies, accessing them, winning deals, adding value, and structuring exits.
• Both Tunguz and Clark value teamwork and prefer to back teams with depth and strong individuals who collaborate effectively.