Capitulation?

Charles Hudson and Manu Kumar are two of the best early-stage investors in the world. This week, they both penned meaningful essays declaring that the fundamentals of early-stage investing have changed, possibly permanently.

Charles states:

For the past 18 months, the Series A market has been very quiet. Outside of AI-related investments, it feels like deal volume is off 75%. The Series A investors I know don’t feel any pressure to make investments and don’t really seem that excited or interested in much these days. Unfortunately for seed-stage companies, the Series A market can remain on strike longer than most seed-stage companies can remain solvent.

He predicts a significant dip in the number of seed-stage companies doing a Series A, a drop in Series As, and fewer extensions or bridge rounds.

Manu Kumar of K9 Capital extends the theme and suggests only companies building real businesses with real customers and revenue will survive. He implores companies to understand the following:

Early stage venture, particularly Pre-Seed and Seed stage venture, is a different game today than it used to be 10 years ago. LPs and GPs should be aware of this dynamic as they make investment decisions.

This follows from Sam Lessin’s theme a couple of weeks ago, declaring that the era of larger checks coming in at later rounds is now over.

At Signalrank, we have always distinguished between organic unicorns, built over many years from the seed stage, and artificial unicorns created by a single large check in an early round. Organic is always best and can survive downturns.

In this week’s video of the week, Jaimie Rhode doubles down on the theme, explaining that in venture capital, only power-law companies matter. Those companies grow to valuations, enabling an entire fund to be returned or more. The venture capital industry relies on the few power law winners returning invested capital.

In the heady days of 2019-2022, it was possible for a power-law company to emerge fast due to a single round of financing. And then quickly go on to do two or three more rounds within a year or two. Charles and Manu correctly point out that this is unlikely, except perhaps in AI. A power law winner will have to be built organically.

The implication is that early-stage investing will need to become once again deliberate and patient. I use the word capitulation (with a question mark) in the title, but this is just a recognition of reality. Capitulation to reality is a good thing. So, no, it is not a capitulation.

But it begs the question, can venture capital support wealth creation if it is really a lottery for a power law winner? Is there a way to benefit from the growth in venture-backed companies without needing to play the lottery of picking individual companies?