Exclusive Insights from Allocate’s Innovation Field Trip
By Nic Millikan, Managing Director and Head of Client Solutions
Last month, Allocate hosted another Innovation Field Trip in San Francisco, an experience that has become a staple on the community calendar. These trips include current and prospective Allocate LPs getting together in an innovation hub like New York, L.A., or the Bay Area, to meet with some of the most sought-after names in venture capital, including Emergence Capital, Lightspeed, Kleiner Perkins, Accel, Susa, and Andreessen Horowitz. On the most recent trip, we explored San Francisco over a day and a half with 20 family offices, visiting with 10 GPs who shared their exclusive perspective on what they are seeing in the current venture landscape.
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We wanted to share the most notable insights.
All-in on A.I.– while it seems that A.I. became a ‘thing’ in the depths of last winter, its roots date back to the 1950’s. It wasn’t until 2010 when hardware advances allowed for the massive computer power that made large datasets, and today’s A.I. possible. Since its awakening, the A.I. use-case has rapidly evolved from image recognition and machine translation, to its breakout moment in language modeling. Just as ChatGPT trains on large language models (LLM), the venture industry is focused on what the next AI transformational app or apps will be. The three areas of focus have been on tooling (the picks and shovels), applications, and the foundation. Proprietary data and datasets offer the potential for companies to create competitive and defensible moats, and these will make it increasingly difficult for competitors to keep pace. With this view, it appears the biggest opportunity in A.I. is at the application level.
Economic cycles don’t last as long as a venture fund – in the U.S., the average economic cycle since 1950 has lasted approximately five and a half years, while venture funds typically have a life of ten or more years. To weather almost two economic cycles, venture GPs need to maintain discipline and be consistent in developing and implementing their thesis, as well as take a long-term perspective. Secular trends drive breakout winners, requiring impeccable timeliness on the part of a GP. Additionally, those GPs taking a contrarian view may have to wait years until their contrarian view becomes consensus, at which point they are generally rewarded for their patience. The investors who will win over time are those who have strong opinions, deep domain expertise, and high conviction in their space – a strong GP-thesis fit. This allows them to say ‘no’ when everybody else is saying ‘yes’.
Revenue is the best source of capital – this should go without saying, but it’s easy to forget during periods when money is cheap, and liquidity is abundant. Today however, with the cost of financing having skyrocketed and liquidity having dried up, the best source of capital for a start-up is revenue from operations. The current environment has forced founders to focus on profitability again. Portfolio companies whose GPs stepped in and helped them out as conditions tightened early last year appear to have fared much better than those who didn’t receive the same support. These GPs helped founders mitigate their cash burn (often aggressively and uncomfortably), extend their runway, and set them on the course to revenue generation, and potential profitability.
Models & metrics matter – there was so much capital flowing through the system from 2018 to 2021 that all the valuation models broke because no one and no deal was measured. We all know the managers who raised mega funds and would fund anything at any price during this period. We also all know what happened to them when the market cooled and valuations reset. On our tour we heard time and again from disciplined GPs that if the valuation is not right, don’t do the deal. Further, don’t adjust the underwriting to make the deal work. The takeaway: stick to GPs who stick to their thesis – or who in this instance, stick to their models and metrics.
In addition to the key takeaways, there were also a few shorter but valuable insights we wanted to share.
The next tech super-cycle is here – there has been no step function change since the smartphone. The digitization of everything reshaped how we interact with the world around us. A.I. is truly transformational and it will not only change elements of every aspect of our lives, but also impact the economy more than the internet did. We are just starting to experience the next tech super-cycle.
Collaboration is key – no one investor knows everything. Collaboration in venture capital is key to success.
Getting deals done – if you can’t source the deal, you can’t do the deal. Having a unique and differentiated deal sourcing method is paramount.
Entry points matter – but entry points over time matter more on the winners. Protecting pro-rata and avoiding dilution are important, but just as important is being mindful of entry valuations. This is especially important as companies scale, enter the hype cycle, and generate broader interest at ever higher valuations.
The exit environment remains tricky – estimates of when we should see a more normalized exit environment ranged from as early as late 2024, to as far out as 2028, though the general expectation was within the next two years.
“The investors who will win over time are those who have strong opinions, deep domain expertise, and high conviction in their space – a strong GP-thesis fit.”
The past couple of years have certainly provided challenges for the venture capital industry. Through innovation and evolution, top-tier managers have managed to navigate challenges and are now well-positioned to capitalize on the future – a future that may start to look very different given the transformational period of A.I.
We hope you learned something new from these insights, and we look forward to having you join us and the Allocate community of GPs and LPs on our next Innovation Field Trip.
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