Burn Baby Burn 🔥
how to counter the moral hazard of VC 🧨
The venture world is evolving at warp speed these days. Every week feels like a year of paradigm shifts. It's the age of mega seed funds. Growth equity firms i.e. PE firms are moving earlier to do direct investments. The rise of massive valuations and preempted Series A reminds me of a term called "moral hazard".
What is moral hazard? In economics, moral hazard happens when an entity has an incentive to increase its exposure to risk because it does not bear the full cost of that risk. Moral hazard is often perpetrated by an entity that is too large to fail. In this case, the weaker party suffers from unintended consequences for parties acting under asymmetric information.
This notion of moral hazard applies to many founders who are raising large seed rounds because there is a lot of dry power in the world.
Unforeseeable effects of raising too much capital for founders:
Contrary to the current zeitgeist, more junior founders may struggle when they raise larger rounds at earlier stages before they find product-market fit. With surplus capital they spend their time hiring head count and people managing instead of finding product market fit, which can be detrimental to long term growth. This moral hazard also affects emerging fund managers who get squeezed in deals where founders jockey term sheets from competing firms to increase their valuation. In short, founders are pressured to raise more money and fund managers are pressured to raise bigger funds.
The venture world is experiencing its own Cambrian explosion with thousands of new emerging funds debuting in 2021 alone. For these new emerging managers, are there alternative models beyond raising mega funds? Two alternatives that pique my curiosity lie in new fund formation structures: DAOs and evergreen fund models.
DAOs offer a self-governing entity for groups of shareholders to pool their money and vote based on investment decisions. Flamingo DAO and Syndicate DAO are great examples of how we can decentralize investing and skip the 2-20 fee structure of fund managers that incentivizes larger and larger funds. Do you really need to pay a GP fee anymore when you have a group of subject matter experts pooling their money together and conferring investment decisions? It seems like DAOs can render the GP role obsolete in a future where LPs don't want to pay high fees and bet on one or two fund managers to manage their money.
Another contrarian fund structure that I love is the evergreen fund model. Virginie Raphael is building Full Circle, a perpetual pre-seed fund focused on investing in a better workforce. Full Circle is unique because the fund only needs to be formed once and LPs become long-term shareholders in that one, single fund. This fund will largely stay the same size during the entirety of its existence, continuing to execute on a consistent investing strategy. This LP shareholder model also allows for early liquidity. For example, Virginie may choose to return the liquidity of a 10X investment to her LPs to either withdraw from the fund or recycle into the next cycle of the fund. Unlike traditional funds that do not generate returns for 10 to 15 years, Full Circle offers early liquidity to her LPs along with future shareholder value.
As we start to imagine what the future venture ecosystem looks like I can't help but wonder what are the contrarians' bets going to look like. While more established funds move towards larger seed funds and fund of funds some new emerging managers may play a different game forming new fund structures. Time can only tell.
 [BR1]Got this stat from Alex Marshall. Not sure where the source is or if we can share this publicly.
Things I'm reading:
I just finished Kazuo Ishiguro's book Klara in the Sun. I love Ishiguro's writing artfully weaving shared humanity with dystopian futures. This book gave me a literary hangover. I spent a whole day reaching for what's real, navigating the gap between humanity the AI. Ishiguro's understanding of human psychology intersecting with technology makes him such a powerful sci-fi writer.
This Atlantic article about the pandemic becoming endemic left me wondering what the new normal is if we can never fully eradicate COVID-19 in the next few years.
With the rise of the Asian American awakening this NYT article about "The Myth of the Asian American Identity" covers the fault lines in the broad spectrum of what socioeconomically and demographically constitutes the categorization of "Asian American". Perhaps Asian American is too broad of identity to categorize us all?
I love Sarah Wood’s substack Joy Soldier about running, writing, and living the sober life. Her marathon meditations on running your own race in life reminded of a lot of Haruki Murakami’s What I Talk about When I Talk about Running.
Things I'm into:
My obsession with skincare and working out has manifested in a nighttime Face Gym routine where I do daily facial exercises and gua sha for lymphatic drainage. I am loving this Face Gym starter kit from Sephora. Every time I do a Face Gym workout I feel so much more relaxed and lighter in my face. It also helps with TMJ!
I've recently given up alcohol for health reasons and found the world of non-alcoholic beverages at Boisson. Boisson is a non-alcoholic liquor store with locations in Cobble Hill, West Village, and Upper East Side. I've fallen in love with spirit-free beverages like Ghia, Aplos, and Kin. Thanks to Boisson I'm able to still share a special moment with an adult beverage without the downsides of alcohol.
Stay curious,
—bo