Decoding Silicon Valley's New VC Rules with 20VC & SaaStr

Harry Stebbings of 20VC and SaaS investor Rory O'Driscoll discuss the evolving dynamics of venture capital. This insightful conversation covers key trends impacting the industry, from OpenAI's acquisition strategy to the challenges faced by seed-stage funds.

Key Takeaways from the 20VC & SaaStr Discussion

  • The 1% Rule in M&A: OpenAI's potential $3 billion acquisition of Windsurf, representing 1% of its valuation, highlights a strategic approach to addressing market weaknesses.
  • Multi-Stage Funds Dominating Seed: Multi-stage funds are outcompeting traditional seed firms due to lower capital costs and the ability to follow-on in later rounds.
  • The 100% Conviction Rule: Investments with 100% conviction of a 5x return are worthwhile, regardless of ownership, though implementation differs between solo GPs and institutional firms.
  • Endowment Liquidity Crisis: Major endowments face liquidity challenges, leading to asset sales due to distribution planning errors and illiquidity in private markets.
  • High Valuations Return: 100x revenue multiples are back, indicating renewed investor appetite for high-growth companies.

OpenAI's Strategic Acquisition

OpenAI's potential $3 billion acquisition of Windsurf signals a strategic move to compete with Anthropic in the AI coding space. This "SVP-level bet" allows OpenAI to address a key weakness without overextending resources.

The Struggle of Seed-Stage Funds

Multi-stage funds are disrupting the seed-stage landscape. Their ability to lead seed rounds, follow-on, and leverage lower capital costs puts pressure on traditional seed firms. Even successful exits may not generate sufficient returns for seed funds given increasing fund sizes and smaller ownership stakes.

Rethinking Revenue Multiples

Focusing solely on revenue multiples without considering growth rates is misleading. High valuations can be justified for companies exhibiting rapid and sustained growth. Today's market allows companies to scale quickly after achieving product-market fit, changing the traditional SaaS growth trajectory.

The Endowment Fund Crisis

Major university endowments are facing liquidity issues, forcing asset sales. This crisis stems from a combination of factors, including down public markets, illiquidity in private markets, and potential changes to tax-exempt status. The severity ranges from cash flow issues to fire sales.

The 5x Return Rule

Investments with 100% conviction of a 5x return should be pursued regardless of ownership or valuation. While this may not always return the entire fund, it guarantees significant returns. However, this approach is more feasible for solo GPs than institutional firms due to strategic and cultural considerations.

AI Rollup Strategies: A Divided Perspective

The effectiveness of AI-powered rollup strategies in fragmented industries is debated. While some express skepticism about integrating acquired customers with varying needs, successful examples demonstrate the potential for significant margin improvement when customer needs are uniform.

San Francisco's Enduring Appeal

San Francisco remains a hub for tech entrepreneurship due to its dense network of talent, capital, and successful companies. This ecosystem fosters serendipitous connections and rapid opportunity assessment, reinforcing its importance despite the rise of remote work.

Additional Insights from the Discussion

  • Two-Meeting Investment Strategy: Investment decisions can be made based on metrics and market positioning before even meeting founders.
  • Prioritizing Growth over Competition: Focusing on growth rate and technical leadership may be more important than the absence of competition.
  • Endowment Cash Planning Issues: Endowment funds face liquidity challenges due to miscalculated distribution planning.
  • Rapid Growth in the AI Market: AI companies can experience dramatic growth and become acquisition targets in a very short timeframe.