Problems Brewing
I think we have a problem brewing in venture capital.
There's an extreme bifurcation happening right now between companies that play into the AI theme, and those that don't. At the most extreme end of opinion, non-AI companies are effectively unfundable unless they are doing absolutely insane levels of growth on par with their AI counterparts. Just a couple of years ago, this wasn't the case. Any company delivering 100%+ year-on-year growth had a shot at raising extra capital. But now I fear that's not enough.
We've been 'retrained' to expect ludicrous speed of growth by a couple of factors.
The first is because for some, it's there. Lovable was probably the pioneer in being quite so forward about how its ARR was scaling (it's much easier to be public about numbers when they are very, very good). Since then, LinkedIn and X are awash with examples of other companies scaling at speeds that a couple of years ago were effectively unthinkable. The demand pull-forward of AI has created a moment in time where the entire world is in-market for AI 'stuff', and that means that when things go well, they go very well, and quickly.
The other forcing function around the expectations of growth is the capital markets dynamics in VC. There is more capital in VC than ever before, and it needs to be invested. At the same time, the risk-free rate of interest is way above the historic lows that we saw during the maturation of VC as an industry. That makes the opportunity cost of capital higher, and therefore the returns that VC has to deliver (on an IRR basis) higher, too. The combined impact of more capital, and higher returns expectations, means that start-ups have to convert larger amounts of capital investment to high value creation, faster than ever. Because of the imperative of growth in making the maths work, that means only a certain type of company (i.e. an extremely fast-growing company) has a hope of achieving the requirement.
So what's the problem I'm worried about?
Twofold.
Firstly, there aren't enough of those super high growth opportunities to return the amounts of venture capital in the industry. That means that capital will concentrate so much into those that look like they have the potential, that valuations will likely inflate away the returns anyway. That is not good for VC as an asset class vying for allocation in a multi-asset-class world.
The second fear is that a lot of good companies won't get funded until this new worldview breaks in some direction. That'd be a real shame, because there are ample examples of companies that took a while to get to scale but have become wonderful companies nonetheless. As one example, Roblox was founded in 2004 and took 5 years before raising a $2m Seed round in July 2009, partly because it focused for so long on getting the physics engine behind its experience right (to be fair, it also helped that the founders had exited a previous business). I'm not sure how this one gets resolved, but it's probably some combination of extreme capital efficiency, acceptance of more sensible valuations along the way, and unbelievable grit and tenacity from founders. Maybe that's a good thing, in the long run, but that's easy to say from the cheap seats of an investor...