I've met with 200 investors in one year. Here's why the current state of venture capital is f***ed and how you can still come out on top.

Investors have been playing a game of chicken within the startup space that somewhat reminds me of a booze-filled evening during my undergraduate days at Florida State University.

After leaving the bars at 2 am on a Thursday night with my good buddy Joe (not his real name, you'll see why I'm not stating it shortly), he peered across the street at the campus Starbucks and shot me a toothy grin. "Bet you won't climb onto the roof of that coffee shop," he exclaimed while slurring his words. To which I replied "oh please, I can climb better than you... I'll do it if you do it."

This back and forth went on for 20 minutes until Joe tripped over a speed bump, fell onto his stomach, and proceeded to urinate himself while laying in the mud-soaked Tallahassee street.

Fast forward to 2024, I can't help but roll my eyes when investors say that they are excited by the positive macroeconomic sentiments that kicked this year off and can't wait to be a part of the action. Yet, they are remaining risk-adverse and only investing if someone else takes the leap of faith, and by the time they do come in, valuation is way too damn high. In this scenario, investors have become just like my buddy Joe - beating their chests in a poor display of attempted alpha male behavior while attempting to be on top of the world (or, a crappy university Starbucks), only to be caught face down in the dirt while pissing their pants.

Now there is hope - Joe went on to become a successful lawyer (yes, really). And maybe... just MAYBE, investors will stop repeating their poor decisions that have heavily contributed to the crash of our economy.

The Startup Investment World: A Comedy of Errors

Here's the problem: in the 2020 and 2021, valuations in the private markets were way too damn high. Hell, you could sneeze on the back of a napkin and it could probably achieve a $10M pre-money valuation. It was the COVID gold rush - everybody was waiting for the bubble to burst... and it just didn't. In the biotech world, we saw companies going public with pre-clinical assets (which is problematic if they dose a patient in clinical trials and it goes south, bye bye company).

Venture capitalists were raising money with ease. Why? Well, in times of low-interest rates such as 2020 and 2021 (3.10% and 2.96%, respectively), inflation can erode the real returns of traditional fixed-income investments. [1] VC investments, which are aimed at high-growth companies, can serve as a hedge against inflation, offering returns that can potentially outpace inflation over the long term. So, their investors (called Limited Partners, or LPs) started pouring capital into VC.

The glory days came crashing to a theatrical and fiery end in 2022. The perfect storm hit VCs:

1. Interest rates started to climb. When interest rates are high, Limited Partners may be less inclined to invest in venture capital firms due to the attractiveness of fixed-income returns, increased cost of capital for startups, concerns over economic slowdown, shifts towards safer investments, and valuation pressures on companies.
2. Initial Public Offerings (IPOs) and Mergers & Acquisition (M&A) activity came to a screeching halt. The only way a VC is going to return capital to their LPs is through an exit. No IPOs/M&A = no exits = no money. [2] Keep in mind that venture capital funds typically have 10 years from raising the capital from LPs to return capital. Imagine having a portfolio of companies on years 8-10 with such limited options to exit!

3. Valuations came crashing to reality. Remember that napkin that you sneezed on that had a $10M valuation? Yeah, people realized it was just a disgusting napkin. And since the valuations came crashing down, that meant that...

4. VCs performed terribly and lost their Limited Partners' money. Here's an example of how that works: A VC raises a $50M fund from Limited Partners. They then deploy all of that capital into a variety of startups in 2020. Fast forward to 2024, that portfolio of companies may now only be worth $25M... yikes!

How are Limited Partners reacting to this mess?

Limited Partners in Venture Capital funds typically come from one of the following:

• High Net Worth Individuals
• Family Offices
• Sovereign Wealth Funds
• Pension Funds
• University Endowments
• Fund of Funds

At the beginning of each fiscal year, these entities take a look at how varying asset classes perform. Let's take a look, shall we?

We'll start by looking at BlackRock 's Asset Return Map [3] . While this doesn't include private equity or venture capital specifically, we can at least start to gauge what the overall macroeconomic environment looks like from a returns standpoint over time:

So, how does venture capital fit into this picture? In 2021, the venture capital index returned a remarkable 54.6%, marking its second-best calendar year ever, trailing only behind 1999 [4] . Then, fast forward to 2022, it was at -20.8% [5] . Whelp, crap.

Now with all of this in mind, let's say that you are an investor looking for places to park your millions/billions of dollars. Would you be investing in venture capital? I doubt it.

With that being said, I have spoken to numerous investors that are still placing their bets on venture capital. However, what I've noticed is that they are skipping out on emerging fund managers and only investing in well-known names and established funds. 麦肯锡 seems to agree with this sentiment, stating that "the 25 most successful fundraisers collected 41 percent of aggregate commitments to closed-end funds (with the top five managers accounting for nearly half that total)." [6]

To me, this is an absolutely ludicrous methodology. Why? Because the top dogs are the ones who got us into this mess in the first place. Don't believe me? Go ahead and re-read Sequoia's apology letter to their LPs for getting them into bed with the whole FTX fiasco , which caused them to lose $150M.

Well, that is a terrible way for Limited Partners to react to this. At least Venture Capitalists are doing the correct things to fix it... right? Right???

Abso-freaking-lutely not.

As a result of the aforementioned LP behavior, VCs are now struggling to raise their next fund. The ones that are successfully raising are only able to accomplish a fraction of what they set out to achieve. Which means that they don't have as much dry powder to deploy. So, they have become incredibly risk adverse and are passing on wonderful startups that have the capability of transforming humanity as we know it.

"But Doug, why does that royally piss you off?"

Great question, coffee-deprived Doug. Let's go ahead and ask the Google machine what the literal definition of venture capital is:

Another issue that I am seeing is that VCs are too focused on name-dropping and perceived prestige to actually look at companies and properly evaluate them. Many investors won't invest in a startup unless it has a brand-name lead investor or has some sort of famous CEO steering the company ship. Startups with excellent products/offerings and young founders that haven't proven themselves yet are now considered obsolete unless they just so happen to know the right people.

Okay, enough ranting. What can Venture Capitalists, Limited Partners, and Startups do to make the best of this scenario and come out on top?

Let's break this down by each player in the ecosystem:

Venture Capitalists

1. Take RISKS. If you see a startup with great technology and potential, yet they just started their raise and the CEO is new to the game... give them a chance!
2. Do your own damn due diligence, don't just take everybody else's word. Sure, you can be the fund that invests alongside Sequoia. Or even better, you could be the first investor in the next Apple/Facebook/Alphabet etc. The latter is a hell of a lot more impressive than the former.
3. Don't be greedy. Yes, now is a buyer's market as valuations are coming back down to reality. However, you need to be realistic with it and don't let your greed let you miss out on an investment opportunity because you were low-balling them on what their company is actually worth.

Limited Partners

1. Invest in emerging venture capital fund managers. Why? Well, we weren't the ones who caused this mess in the first place. While the previous players in the space let everything crash and burn, we carefully studied this behavior. We know what went wrong, which is why we have carefully developed investment theses that will hopefully prevent this from happening again.
2. Keep in mind that last year's trends do not correlate to this year's trends. There are countless ways to slice and dice your investment philosophy based off of historical data, but they are all just theories. Last year's top performer could be this year's worst, and vice versa.
3. Remember that the markets are cyclical. This statement has held true for nearly a century now. Venture capital has had a rough 2 years, for sure. But interest rates will EVENTUALLY drop again. M&A/IPO activity WILL pick up again. And as a result, VC will flourish once again. While you can never time the markets, perhaps now is a good time to lock your capital into a VC fund for 10 years. Millionaires are made in bull markets; billionaires are made in bear markets.

Startups

1. Don't give up. This is one of the worst capital raise markets that we've seen in years. But, if you are able to get through this, then the world is your oyster.
2. Continue to build your network, and be relentless about conveying your value proposition. VCs are meeting dozens of startups and receiving hundreds of emails per week. Stay on our radar by providing monthly/quarterly updates. Show us that you are consistently steering your ship forward. And, don't be afraid to ask for intros to other investors.
3. Get professional help, if you need it. On top of my role at Intelligence Ventures, I also serve as the Principal & Founder of Renegade BioConsulting . Here, I've consulted for dozens of startups where I've helped them as a fractional CXO, investor relations/capital raiser, market intelligence, and strategy navigator. Again, I've met with over 200 investors and 200 startups this year. If you are looking for help, feel free to reach out: [email protected]

More about Intelligence Ventures

We are an emerging venture capital firm dedicated to cultivating innovation at the intersection of artificial intelligence and healthcare within the United States. Our commitment lies in the strategic investment and nurturing of pre-seed, seed, and Series A companies, fueling their growth and fostering the next generation of industry leaders.

Our initial fund, AI Health Fund I, is focused on companies that use artificial intelligence to increase efficiencies and/or solve computationally intractable problems that place a ceiling on our ability to develop new drugs, advance them through clinical trials, and ultimately diagnose and treat patients. We are industry vertical agnostic and believe that generative AI and more specific ML models can be used to accelerate innovation in biotech, pharma, medtech, and diagnostics.

For more information, visit our website at www.intelligencevc.com or reach out to [email protected] for any inquiries. Be sure to follow us on LinkedIn and Twitter , and subscribe for further installments of The Intelligence Report .

References:

1. Miller, P. (Updated by Kadzielawski, A.). (2024, March 13). Mortgage rates chart: Historical and current rate trends. The Mortgage Reports. Retrieved from https://themortgagereports.com/61853/30-year-mortgage-rates-chart
2. Statista Research Department. (2024, February 7). Number of IPOs in the U.S. 1999-2023. Statista. Retrieved April 6, 2024, from https://www.statista.com/statistics/270290/number-of-ipos-in-the-us-since-1999/#:~:text=In%202021%2C%20there%20were%201%2C035,to%20181%20and%20154%20respectively .
3. BlackRock Investment Institute. (n.d.). BlackRock Asset Return Map. BlackRock. Retrieved April 6, 2024, from https://www.blackrock.com/corporate/insights/blackrock-investment-institute/interactive-charts/return-map
4. Slotsky, C. (2022, August). US PE/VC Benchmark Commentary: Calendar Year 2021. Cambridge Associates. https://www.cambridgeassociates.com/insight/us-pe-vc-benchmark-commentary-calendar-year-2021/
5. Tonning, A. H. (2023, September 5). Venture capital — an attractive and proven asset class for long-term financial returns. Alliance VC. Medium. https://medium.com/alliance-venture/venture-capital-an-attractive-and-proven-asset-class-for-long-term-financial-returns-c2a5eb762173
6. McKinsey & Company. (2024, March 28). McKinsey Global Private Markets Review 2024: Private markets in a slower era. https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/mckinseys-private-markets-annual-review