From: allin
The current landscape of venture capital and entrepreneurship presents significant challenges, particularly concerning liquidity, fund management, and the broader economic environment. The industry is described as a “really, really tough business” [00:48:59].
Liquidity and Fund Management Challenges
Generating liquidity for venture capital funds has become “super super hard” [00:50:03].
Elongated Liquidation Timelines
Companies now take much longer to generate liquidity, typically in years 11, 12, or 13, compared to the past where it was possible by year five, six, or seven [00:50:48]. This means the 10-year period of traditional venture funds (which can be extended to 12 years) is often insufficient to generate a meaningful outcome [00:54:32]. For some companies, it could take more than 15 years to see a liquidity event [00:55:17].
“The job is not to maximize absolute every single win, the job is to return capital in a reasonable time period so that your investors don’t run out of money to give you” [00:52:09].
Reliance on Secondary Markets
Given the extended timelines, the emergence of secondary markets has been crucial for VCs to generate distributions [00:52:50]. Without these markets, many funds would struggle to return capital to their limited partners (LPs) [00:52:51].
Distorted Ownership Stakes
During the period of peak zero interest rates, a “peanut butter effect” [00:57:28] led to:
- Talent spreading out, with many experienced individuals leaving to start their own companies [00:57:42].
- Founders rushing into the same verticals due to too much capital, resulting in up to 20 startups pursuing the same opportunity [00:57:51].
- Earnings and customers being spread across numerous competing products [00:58:00].
- VC ownership stakes becoming diluted, with a Series A round yielding 10% instead of 20%, and a seed check getting 1% instead of 5% [00:58:20]. This dilution makes it harder to achieve significant distributed to paid-in capital (DPI) [00:58:23].
These factors combine to erode the return stream for both general partners (GPs) and limited partners (LPs) [00:58:28]. The average returns are predicted to decay by 50% to 100% [00:58:41].
IPO Process and Market Access
The IPO process is currently “broken” [00:53:23], largely due to anti-tech sentiment and regulatory pressure (e.g., Lina Khan) [00:53:08]. Large companies are less likely to acquire startups, choosing instead to build competing solutions in-house [00:53:16]. This means there are “very very few ways of accessing Public Market capital and exposure” [00:59:51], creating an unsustainable industry model [00:53:50].
Fund Manager Proliferation and Washout
There was an “explosion in fund managers” [00:55:35], with a ton of capital entering the industry, especially in 2020 and 2021, when the federal government injected 200 billion annually, compared to a normal range of $60-100 billion [00:55:55]. This led to larger rounds and inflated valuations, essentially doubling entry prices and eroding potential returns [00:56:06].
The percentage of first-time VC managers who raised a second fund has dropped from over 50% to below 15% [00:48:51]. This suggests that a significant number of fund managers will be “washed out of the industry” [00:59:23].
Impact on Startup Ecosystems
The environment for startups has shifted significantly.
Labor Market Dynamics
Previously, it was difficult to find talent, with 11-12 million jobs available at the peak, making it challenging for early-stage startups to hire [00:14:04]. Now, the situation has reversed, with an abundance of viable candidates for positions [00:14:48]. This change is partly attributed to immigration and outsourcing [00:15:07].
Concerns for the Upper Middle Class
There are concerns about the “hollowing out of the upper middle class” [00:17:17], specifically $150,000 jobs, due to outsourcing and increased labor supply.
Tail of Two Cities in Tech
Within the tech industry, there’s a “Tale of Two Cities” [00:16:00]:
- AI Sector: Things are “really bubbly” with a “huge AI Tailwind” [00:15:56] and significant investment [00:15:58].
- Non-AI Sector: Valuations and company operations have returned to “much more normal levels” [00:16:07].
The Role of AI in Disruption and Capital Efficiency
AI is poised to create significant disruption, particularly in call centers, where level one customer support will likely be replaced by AI within two to three years [00:18:29]. This is because AI can be trained on large datasets (product documentation, previous emails, recorded calls) [00:25:45] and the tolerable error rate in customer support allows for phased implementation, starting with level one [00:20:50].
AI is also enabling new levels of automation and efficiency, with “AI-powered software” [00:22:27] achieving 100% accuracy in highly regulated industries after extensive engineering [00:22:56]. This kind of technology can lead to the deprecation of expensive enterprise software systems like Salesforce or Workday by creating “digital twins” [00:28:41] that replicate their functions.
Implications for Capital Allocation
The rise of AI suggests that successful companies may need “a lot less capital” [00:59:32]. An AI company with 20 people doing the work of 2,000 might only need $10-15 million in funding instead of hundreds of millions [00:59:06]. This points to a “right sizing of capital problem” [01:00:09] for the industry.
The Current Economic Outlook
Fed Rate Cuts and Market Reaction
The Federal Reserve cut interest rates by 50 basis points, the first cut since March 2020, bringing them down from a 23-year high [00:07:07]. Historically, 50 basis point cuts (like in 2001 and 2007) have preceded market falls (31% and 26% respectively in the two years after the cut) [00:09:04]. The 2020 cut, influenced by COVID-19 and massive economic stimulus, was an outlier, with the market rising 44% [00:09:08].
The Fed’s actions, signaling further cuts, are a “stimulatory move” [00:10:18] intended to stimulate the economy due to underlying economic tension [00:10:32]. This suggests potential pressure on company earnings and a possible contraction in the value of financial assets [00:11:17].
Inverted Yield Curve and Recession Indicators
The yield curve inverting (short-term interest rates exceeding long-term rates) has historically been an “almost perfect gauge” [00:16:29] of an impending recession. The recession typically follows when the yield curve “de-inverts” [00:16:59], as the Fed dramatically cuts short rates in response to economic weakness [00:17:04]. The yield curve has recently de-inverted [00:17:23], raising concerns about a potential recession.
The “Golden Era” Bubble and Its Aftermath
The period around 2020 and 2021 saw a massive “liquidity bubble” [00:56:23], partly driven by the federal government’s $10 trillion liquidity injection [00:55:39]. This led to “stratospheric” valuations [01:05:23] and huge distributions to LPs in 2021, which in turn encouraged more and larger fund raises [01:05:32]. This created “vintage distortion” [00:57:02], making it difficult to assess true value.
While the industry is still working through the “hangover” [00:56:23] of this period, the excitement around AI could lead to a new “Golden Era” [01:07:09], especially if interest rates decline substantially.