Private Markets and AI Drive Generational Company Value Creation
TL;DR
- Mega-funds can outperform smaller ones by capturing a greater number of high-value winners, as demonstrated by a16z's $1 billion fund returning 7x from Databricks alone.
- The private markets have grown significantly, with 53% of market gains occurring post-Series C, indicating substantial value creation opportunities in later-stage private companies.
- Companies staying private longer benefit investors by allowing increased ownership over time, contrary to concerns about competitive dynamics or liquidity issues.
- The diminishing number of public companies and declining return on invested capital in public small-cap indices suggest private markets are now the primary venue for high-quality growth.
- Investing in founders with "strength of strengths" is paramount, prioritizing spiking founder capabilities over mitigating weaknesses to avoid missing opportunities due to theoretical competition.
- AI's impact is shifting spend from human labor to technology, evidenced by a 40% productivity increase in truck brokerage, leading to significant margin expansion.
- High revenue growth in AI companies is only valuable if coupled with high retention and engagement, requiring a higher bar for assessing quality and sustainability.
- The "capital as a weapon" strategy is difficult in enterprise due to the need for physical hiring, making brand and founder strength more critical for anointing category winners.
Deep Dive
Andreessen Horowitz's Growth fund strategy leverages the expanding private market and the transformative potential of AI to identify and back generational companies, asserting that large fund sizes do not inherently limit returns and that the future of significant value creation lies within private technology markets. This approach requires a sophisticated understanding of market dynamics, founder strengths, and the evolving landscape of AI, as the firm actively seeks to "fix mistakes" by investing in promising companies that may have been overlooked at earlier stages.
The expansion of private markets has fundamentally altered the investment landscape, shifting the primary locus of value creation from public markets to private ones, particularly in technology. Historically, a significant portion of a company's gain occurred before Series C, but analysis shows that 53% of gains now happen from Series C onwards, meaning companies stay private longer, offering venture investors more opportunities to increase ownership. This trend, coupled with the creation of massive market caps through tech waves like cloud and AI, necessitates larger fund sizes to capture meaningful stakes in these increasingly large companies. The firm believes that the private market offers a cheaper cost of capital than public markets, despite higher absolute valuations, due to reduced volatility and greater control over narrative and employee management. This shift means that institutional investors must re-evaluate asset allocations, recognizing private venture as a mature, core asset class rather than a niche one, capable of outperforming private equity due to its exposure to the next generation of dominant tech companies, especially those leveraging AI.
AI is not merely a new category but a fundamental driver of disruption, impacting business models, UI/workflow, and data access. While AI can drive significant productivity gains, as seen with CH Robinson's 40% shipment increase, the transition from human labor to technology budgets is crucial for sustained growth. The firm's investment thesis emphasizes backing companies with "strength of strengths," focusing on founders with exceptional capabilities in areas like brand building, company building, and product vision, rather than solely on mitigating weaknesses. This philosophy guides investments in companies like Flow, where Adam Neumann's unique strengths in brand and consumer experience are central to the investment thesis, despite market skepticism. The firm also acknowledges the "AI productivity tax" and the need for integrated AI solutions like Superhuman, while recognizing that AI models are unlikely to subsume all application software, creating opportunities for companies building around these models. The firm's growth fund acts as a "fix the mistake fund," investing in companies its early-stage team may have passed on, reinforcing its commitment to backing category leaders and managing potential conflicts by investing across different funds and allowing companies to diverge rather than converge.
The future of technology investment is increasingly concentrated in AI and personal health management, with robotics poised to become the largest category within AI. The firm believes that while AI models will become more efficient, leading to rationalized margins, the primary value will be created by companies building sophisticated applications and services on top of these foundational models. The increasing scale of private markets and the transformative power of AI mean that the quality and speed of execution are paramount, with a strong emphasis on market pull and organic customer acquisition. Despite the high valuations, the firm maintains that for truly exceptional companies demonstrating rapid growth and high engagement, especially those leveraging AI, these valuations are warranted due to the sheer magnitude of the opportunity and the potential for asymmetric returns.
Action Items
- Audit AI company revenue models: Assess retention and engagement metrics for 3-5 recent investments to validate growth sustainability.
- Implement founder strength framework: Develop criteria to evaluate "strength of strengths" for 5-10 new investment pitches, prioritizing core competencies over weakness mitigation.
- Analyze market pull for AI startups: Identify 3-5 AI companies demonstrating significant organic customer acquisition or low-cost sales to validate market demand.
- Track AI model cost vs. usage: Monitor input costs per token and reasoning-driven usage for 2-3 AI portfolio companies to assess margin rationalization trends.
- Evaluate AI impact on labor budgets: For 3-5 companies, measure the transition of spend from human labor to technology budgets and its ROI.
Key Quotes
"Our best performing fund in the history of the firm is actually a 1 billion fund so it's a large fund in that fund databricks has returned 7x to the fund so far coinbase has returned already dpi'd 5x of the fund in that fund we also had github digital ocean lyft and many other things to me you can kind of see it in the data and our returns already it's about the number of winners you capture and if the big ones are great that can really work out so i think the idea that large funds can't have great returns is just not true in our experience"
David George argues that large fund sizes do not inherently limit returns, citing a $1 billion fund as the firm's best performer. George highlights that the key to high returns is capturing a sufficient number of successful companies, and that large winners within a large fund can indeed drive outsized performance, contrary to common belief.
"The number of public companies has been cut in half over the last 20 years you know the companies that we're talking about many of them would have already been in the public markets and they're not and so you know if you look at where the returns are getting generated the returns are actually getting generated in the private markets before they go to the public markets"
David George points out a significant trend: the decrease in the number of publicly traded companies over the past two decades. George explains that this shift means many companies that would have previously gone public are now remaining private, and consequently, a substantial portion of investment returns are being generated in the private markets before companies potentially enter the public sphere.
"The biggest advantage is not so much that because i think in the fullness of time if you're transparent you tell a good story you share with the public markets they'll kind of understand your business i think the biggest advantage is the avoidance of volatility in your stock price and sort of employee management you know if you can kind of steadily grow or control your stock price in the private markets even if it's a slight discount to where you would be in the public markets i get the benefit of that for sure"
David George suggests that a primary benefit of remaining private is not necessarily easier access to capital, but rather the ability to avoid stock price volatility and manage employee compensation more effectively. George elaborates that by controlling stock price fluctuations in the private market, companies can achieve steadier growth, which is a significant advantage even if it means a slight discount compared to public market valuations.
"If you overweight the fear of future theoretical competition you can always talk yourself out of making an investment and so we try really really hard not to do that other other mistakes if we if we pass on great companies you know it's not because of their you know the market leader it's not because they have a good business model it's because we think the market might be too small those are mistakes too like we always underestimate the size of a market and we have fun stories about that all over the place we do"
David George articulates a core investment philosophy: avoiding paralysis by overthinking potential future competition. George explains that this fear of theoretical competition can lead investors to miss out on promising opportunities, and that a common mistake is underestimating the actual market size for innovative companies.
"The number one way to measure a company is ultimately return on invested capital the way you do that with an early stage company mostly is efficiency of customer acquisition not every company needs to go you know zero to 100 like it depends on what market they're in but i do think the companies with ai if there's very sort of starving end customers high momentum gives you a chance to build a moat and i think that's the most important thing about this sort of debate about how high of growth is is good enough it depends on what market you're in"
David George posits that return on invested capital is the ultimate measure of a company's success, particularly emphasizing the efficiency of customer acquisition for early-stage businesses. George notes that for AI companies with strong customer demand and momentum, the ability to build a competitive moat is paramount, and the required growth rate is contingent on the specific market dynamics.
"We look for situations like that i would contrast it with situations like the original softbank vision fund did a lot of really good things honestly they did a bunch of really good things like what i genuinely want to be educated here because i immediately shivered they were early to figuring out that there would be a huge opportunity in ai so you know they famously were in nvidia in that fund you know and they did some really good investments like slack like garnett the one piece of it was missing was that capital as a weapon was a viable strategy"
David George contrasts a16z's investment approach with that of the SoftBank Vision Fund, acknowledging SoftBank's early recognition of AI opportunities and investments in companies like Nvidia and Slack. However, George identifies a key difference: SoftBank's strategy of using "capital as a weapon" was not as viable in enterprise markets, which require more than just capital infusion to succeed.
Resources
External Resources
Books
- "The Twenty Minute VC: Venture Capital, Startup Funding, and The Pitch" by Harry Stebbings - Mentioned as the podcast where David George previously appeared.
Articles & Papers
- "The AI Productivity Tax" (Implied concept from podcast description) - Discussed as a problem solved by Superhuman.
- "The Tam Trap" (Implied concept from podcast discussion) - Discussed in relation to why SaaS might be perceived as having smaller Total Addressable Markets.
People
- David George - General Partner at Andreessen Horowitz, leading the Growth investing team.
- Harry Stebbings - Host of "The Twenty Minute VC" podcast.
- Adam Neumann - Founder of Flow, discussed for his strengths in brand building and company building.
- Anish - Mentioned in relation to leading a Series A round for Deal.
- Ben Horowitz - Co-founder of Andreessen Horowitz, discussed for his strengths as a management coach and futuristic thinker.
- Brian Kim - Mentioned as part of the Andreessen Horowitz growth funds team.
- Dixon - Mentioned as having the clearest articulation of Andreessen Horowitz's early-stage strategy.
- Everett Randall - Mentioned as having stated that large fund sizes reduce returns.
- Gary - Mentioned as someone the speaker is a fan of.
- Jennifer - Mentioned in relation to an early-stage round for 11 Labs.
- John Collison - Mentioned for his perspective on why Stripe might not go public.
- Mark Andreessen - Co-founder of Andreessen Horowitz, discussed for his ability to see the future and his consumer internet expertise.
- Maddie - Founder of 11 Labs, discussed as an example of a European entrepreneur.
- Nomi - Mentioned in relation to an investment in Character.ai.
- Pat - Mentioned as a potential co-investor.
- Santiago - Partner at Andreessen Horowitz, mentioned for having dinner with Shiv from Abridge.
- Sarah - Mentioned as leading investments in Decagon.
- Shiv - Founder of Abridge, discussed for his archetype of knowing his end market, product, and technology while being a killer.
- Winston - Mentioned in relation to Harvey.
Organizations & Institutions
- Andreessen Horowitz (a16z) - Venture capital firm where David George is a General Partner.
- 11 Labs - AI startup backed by Andreessen Horowitz.
- Abridge - AI startup backed by Andreessen Horowitz.
- Adp - Mentioned in relation to payroll services.
- Amazon - Mentioned as a scale player in retail.
- Anduril - Company backed by Andreessen Horowitz.
- AngelList - Platform for venture funds.
- Anthropic - AI company discussed as a potential competitor to OpenAI.
- Benchmark - Venture capital firm.
- Calm - Company mentioned in relation to its founder.
- Character.ai - Company where Andreessen Horowitz led a round.
- Ch Robinson - Truck brokerage company that has seen productivity increases from AI.
- Coinbase - Company that has returned capital to Andreessen Horowitz's fund.
- Coda - AI tool integrated into Superhuman.
- Crowdstrike - Company mentioned as an example of a large software company.
- Cursor - AI startup backed by Andreessen Horowitz.
- Databricks - Company backed by Andreessen Horowitz.
- Decagon - Company in the customer service space.
- Deal - Company mentioned in relation to its founder and potential customer.
- Doordash - Company mentioned as an example of a large software company.
- Early Stage Team (Andreessen Horowitz) - Mentioned in relation to partnership with the growth fund.
- Facebook - Mentioned in relation to monetization and potential future competition.
- Figma - Company backed by Andreessen Horowitz.
- Flock Safety - Company discussed in relation to competition with Axon.
- Founder's Fund - Venture capital firm.
- Gmail - AI tool integrated into Superhuman.
- Google - Mentioned in relation to AI efforts and competition.
- Grammarly - AI tool integrated into Superhuman.
- Grubhub - Mentioned as a potential competitor to DoorDash.
- Gtmhub - Mentioned as a potential competitor to Deal.
- Harvey - AI startup backed by Andreessen Horowitz.
- Hummingbird - Venture capital firm.
- Invest Like the Best - Podcast where David George previously appeared.
- Japan - Mentioned in relation to a shrinking population and market.
- Kingmaker - Concept in venture capital.
- Laura Piano - Mentioned in relation to a clothing brand.
- Leaf Fixel - Mentioned as someone with a 10-year vision plan.
- London - Mentioned as a market for Waymo.
- LPs (Limited Partners) - Investors in venture capital funds.
- Mail - AI tool integrated into Superhuman.
- Mark Cuban - Mentioned in relation to a potential investment.
- Microsoft - Mentioned in relation to headcount reduction.
- Monday.com - Company mentioned as an example of enterprise software.
- Napolean - Mentioned as a respected figure in venture capital.
- New England Patriots - Mentioned as an example team for performance analysis.
- New York Times - Publication that featured an op-ed on Waymo.
- Nvidia - Company mentioned in relation to Softbank's Vision Fund.
- Notion - AI tool for documentation.
- OpenAI - AI company backed by Andreessen Horowitz.
- Palo Alto - Location of an Andreessen Horowitz office.
- Paychecks.com - Mentioned in relation to payroll services.
- Paypal - Mentioned in relation to payment processing.
- Pff (Pro Football Focus) - Data source for player grading.
- Public Markets - Discussed in relation to investment opportunities.
- Rblx - Mentioned as a potential competitor to Deal.
- Revolut - Company that the speaker regrets not investing in.
- Rolls Royce - Mentioned in relation to a luxury brand.
- Russell 2500 - Index mentioned in relation to Return on Invested Capital.
- Salesforce - Company mentioned as an example of a large software company.
- SaaS (Software as a Service) - Business model discussed in relation to market dynamics.
- Slack - AI tool for communication.
- Snowflake - Company mentioned as an example of enterprise software.
- Softbank Vision Fund - Mentioned for its investment strategy.
- SpaceX - Company backed by Andreessen Horowitz.
- Specialized Retail - Discussed as a segment of the retail market.
- Spicy - Adjective used to describe a podcast episode.
- Stripe - Company backed by Andreessen Horowitz.
- Superhuman - AI productivity suite.
- Swyftx - Mentioned as a potential competitor to Deal.
- Tech Waves - Discussed as drivers of market value.
- The Twenty Minute VC (20VC) - Podcast name.
- Tiktok - Mentioned as a potential exception for capital as a weapon in consumer markets.
- Tools - Category of resources.
- Twilio - Company mentioned as an example of enterprise software.
- Uber - Mentioned in relation to entering the London market.
- US West Coast - Location of many top technology companies.
- Vanta - Company providing security and compliance solutions.
- Venture Capital - Investment strategy.
- Videos & Documentaries - Category of resources.
- Walmart - Mentioned as a scale player in retail.
- Waymo - Autonomous driving company.
- Workday - Company mentioned as an example of enterprise software.
- Xai - Mentioned in relation to AI companies.
- YC (Y Combinator) - Accelerator program mentioned as a significant buyer in venture capital.
Tools & Software
- ChatGPT - AI tool for writing.
- Coda - AI tool integrated into Superhuman.
- Grammarly - AI tool integrated into Superhuman.
- Mail - AI tool integrated into Superhuman.
- Notion - AI tool for documentation.
- Slack - AI tool for communication.
- Superhuman - AI productivity suite.
Websites & Online Resources
- vanta.com/20vc - URL for Vanta discount.
- superhuman.com/podcast - URL for Superhuman information.
- angellist.com/20vc - URL for AngelList information.
Other Resources
- AI Productivity Tax - Concept describing loss of context and time due to fragmented AI tools.
- Capital as a Weapon - Investment strategy discussed in relation to its effectiveness.
- Kingmaking - Concept in venture capital where a financier anoints a winner.
- Liquidation Preference - Term related to investment terms.
- Market Pull - Concept describing customer demand for a product.
- Mega Funds - Large venture capital funds.
- Return on Invested Capital (ROIC) - Metric for company performance.
- Strength of Strengths - Investment philosophy focusing on founder's core competencies.
- TAM Trap - Concept related to overestimating market size.
- Theoretical Competition - Fear of future competition as a reason to avoid investment.