Venture Fund Size Growth, the Rise of Unicorns, and more with Elizabeth Yin and Zach Coelius | E1886

Episode Summary

Executive Summary: This podcast episode features a panel of venture capitalists discussing the current state of venture capital fundraising, fund sizes, and investment strategies. Key topics include the shift towards smaller funds outperforming larger ones, the return of in-person networking in the Bay Area, and the decline of capital efficiency. The panelists share insights on their recent investments, emphasizing the importance of differentiation and network-driven deal flow.

Main Topics: Venture Fund Sizes and Fundraising Challenges (Priority: 5/5): Discussion on the increase in median venture fund size despite a 62% drop in total capital raised, highlighting a brutal fundraising environment and a flight to quality by LPs. Smaller Funds vs. Larger Funds Performance (Priority: 5/5): Analysis of historical data showing small funds (under $400M) have significantly higher IRRs (20%) compared to larger funds (7.2% for $400M-$1B, 2.4% for over $1B), attributed to easier deployment and less competition. Bay Area's Dominance in Venture Capital (Priority: 4/5): Debate on whether the Bay Area is back as the premier startup hub, citing $63B raised in 2023, density of talent, and return to in-person events, though remote work allows global investment. Capital Efficiency and ZIRP Era Impact (Priority: 4/5): Examination of how zero-interest-rate policy (ZIRP) led to overcapitalization, declining capital efficiency (enterprise from 26x to 7x), and the current market correction forcing efficiency. Portfolio Construction and Investment Strategies (Priority: 4/5): Exploration of different models like small-check, high-volume investing (Hustle Fund, Launch) vs. network-driven selective investing (Coleus Capital), focusing on early-stage alpha. Recent Portfolio Investments (Priority: 3/5): Panelists share their last three investments: Shovels.ai (AI for government data), Anadro (energy fintech), PodcastAI (AI for podcast production), EchoMark (document watermarking), Bruin Health (mental health platform for physicians), and others, highlighting differentiation and founder quality.

Key Arguments: Smaller funds outperform larger ones because they can deploy capital more efficiently, avoiding competition for late-stage deals and bidding up valuations. The ZIRP era created a bubble of overcapitalized, inefficient companies; current market correction will produce stronger, capital-efficient startups. Bay Area density of talent and ambition makes it the best place to build a world-class company, but remote tools allow successful global investing. LPs are penalized for failure but not rewarded for success, leading to risk-averse allocations to established managers despite better returns from emerging funds. Differentiation and insight are crucial for startup success; crowded spaces lead to high customer acquisition costs and fundraising difficulties. Network-driven deal flow yields higher quality investments than processing thousands of applications, though both models can work.

Data Points: Median venture fund size increase: $26M to $37.4M - Year-over-year increase from 2022 to 2023 Total venture capital raised drop: 62% - Year-over-year decrease in total capital raised Number of funds closed: 474 - In 2023, roughly a third of 2022's count Bay Area startup funding: $63B - Total raised in 2023, more than next 10 markets combined Small fund IRR (1969-2015): 20% - For funds under $400M Large fund IRR ($400M-$1B): 7.2% - For same period Enterprise capital efficiency decline: 26x to 7x - From 2013 to 2023 Unicorn count increase: 39 to 532 - From 2013 to 2023, 14x increase Unicorn exit rate: 7% - Down from 66% in 2013 Hustle Fund application volume: 12,000 - Annual applications, with ~100 investments Launch application volume: 20,000 - Annual applications, with ~100 investments

Pivotal Quotes: "The second area is stuff that I'm actually smart in. Turns out I'm kind of dumb in a lot of spaces. So, you know, I'm not particularly good in consumer. I don't have any ability in bio. I'm not a crypto guy. I don't do chips. I try to do, don't do any hardware. So there's a bunch of sort of negative filters that I can get rid of there very, very rapidly." — Zach Coleus: Explaining his rapid deal filtering process based on domain expertise "If I were to kind of tie up why running a smaller fund... is easier than a larger fund... even if you have a company that isn't going to be a unicorn... you can still actually get 50x or 100x out of a great company if you come in early enough." — Elizabeth Yen: Arguing that small funds can achieve high multiples from early-stage investments "The best ones come last summer, suddenly reignited, and they're growing like crazy again. And even with a lot less cash and even with a lot less VC support, because the other thing that happened is a lot of their competitors just disappeared." — Zach Coleus: Describing portfolio companies recovering post-ZIRP correction

Implications: The venture capital industry is undergoing a correction, favoring smaller, more efficient funds and capital-efficient startups. Founders should focus on differentiation and efficient growth. The Bay Area remains the top ecosystem, but remote investing widens opportunities. LPs are cautious, making fundraising harder but potentially leading to higher quality investments.