Episode Description
It was a pleasure to sit down this week with Josh Kopelman, one of the original architects of seed stage investing who continues to re-invent what it means to operate within venture.
Josh co-founded First Round Capital, which has invested at the earliest stages in companies like Square, Uber, and Roblox. Some of Josh's more recent investments include Notion, Pomelo Care, Loyal, and Perpay. Since First Round's inception in 2004, Josh has invested in 500+ startups and has frequently made the Forbes "Midas List" which ranks the top 100 tech investors.
Josh has been a founder three times (four if you include founding First Round). In 1992, while in college, he co-founded Infonautics Corporation – and took it public on NASDAQ in 1996. Josh co-founded Half.com in 1999 and led it to become one of the largest sellers of used books, movies and music in the world. Half.com was acquired by eBay in 2000, where Josh remained for three years. In late 2003, Josh helped to found TurnTide, an anti-spam company that created the world's first anti-spam router. TurnTide was acquired by Symantec just six months later.
Segment 1: Dot-Com Bubble Lesson on Holding (0:00 - 0:19)
Josh Kopelman: It was universally acknowledged we were in a bubble. Everybody knew it. Oh, like the Fed chair, irrational exuberance, pets.com sock puppet, like total irrationality. And if you had said, oh no, we're in a bubble, and you said I want to sell and exit now, you would have given up 83% of your profit. You would have made 17% of the total returns you could have made.
Segment 2: The Changing VC Landscape (0:25 - 1:06)
Jack Altman: I want to start with the state of venture. So you started First Round in 2004, so it's over 20 years now, which is awesome. And, um, you've seen a bunch of cycles and venture has changed like a huge amount in that time. And the lay of the land today is different than it's ever been... where now we've got not just like one or two big firms, but you've got like six or eight or 10 venture firms that are billions and billions of dollars. And we're not that big of an overall ecosystem in venture. And then of course you have a lot of smaller firms, but it seems categorically different because now you're hearing about firms that are playing different games than we've ever played before.
Segment 3: GP vs. LP Dynamics & Growth (1:16 - 2:01)
Josh Kopelman: It's been fascinating to watch. So, I think we should talk about it two ways. The first way we could talk about it is how is it playing at the GP side and how's it playing at the LP side? Because at the GP side, right, in 2004, you had fewer than 850 funds... If you looked at like active check writers, people that were writing more than one check a year, probably 1,000, 2,000 people. Today, there's over 10,000 funds, you probably have over 20,000 active check writers out there... Does it make the industry harder for VCs? Sure. Is it probably better for entrepreneurs? Yeah, more capital out there funding more ideas. I think what hasn't been talked about are these fund size changes and what that means for LPs.
Segment 4: The LP Shift & "Blackstonification" of Venture (2:01 - 3:48)
Josh Kopelman: You know, I think when we started, David Swensen pretty much like created the institutional venture asset class... he put us in business at First Round at Yale... And you had like university endowments and a very select customer that basically said, we'll take illiquidity in order to get outperformance... And they really like those two matched, right? You needed to have 10 plus years illiquidity in order to get a 20 plus percent IRR and that was the deal. And it happened... But I think there are a lot of smart investors out there and smart VCs and they said, you know, there's a lot of capital out there... A lot of capital with like bigger purses, sovereign wealth funds, etc. And you know, they might be willing... they might have a different cost of capital. They might instead of targeting a 25% or a 4X, they might be looking at a 2X or a 12% IRR and they'll take the same illiquidity. And when you bring new investors with different capital returns expectations, it could be really transformational for the industry. So like the bull case is the Blackstonification of venture, right? You know, what Blackstone did is say it's not about alpha, it's about scale... If you had a billion dollars and it was a traditional venture fund and it could do 30% IRR, that's awesome. That's like $300 million. And if you had $100 billion fund and it could do 12% IRR, well, that's $12 billion. That's a lot more than the $300 million... So in terms of a total cash return from an asset under management, total profit dollars generated, like the Blackstone model won.
Segment 5: The "Venture Arrogance Score" (4:46 - 5:52)
Josh Kopelman: I've created something which I don't think I've shared publicly, but I've run inside First Round... Let's call it the Venture Arrogance Score. All right. So you take a fund. Say that fund is a $7 billion fund. Then you look and say, so you need two numbers to understand any fund's business model. First is how large is the fund? $7 billion. The next is what percent of a company do you think they'll own on exit? And so like, are they going to own 30% like they did 20 years ago? Or are they going to own 8% or 10%? And like today it's trending to 10%... So if you have a $7 billion fund and you're going to own 10% of the companies that you're in on average, you just figure out, okay, for each turn of the fund, that's $70 billion, right? Like you the founders need to create $70 billion worth of value in your basket for your 10% to be worth 7 billion.
Segment 6: Concentration of Returns & Holding Discipline (27:04 - 27:31 & 28:08 - 28:15 & 28:47 - 29:28)
Josh Kopelman: [Referring to the dot-com bubble] 1% a year for the first 17 years, 83% in the last three. And why is that important? Because the last three, it was universally acknowledged we were in a bubble... total irrationality. And if you had said, oh no, we're in a bubble, and you said I want to sell and exit now, you would have given up 83% of your profit. You would have made 17% of the total returns you could have made... ...we don't make our money in equilibrium... we make our money in the extreme fucking greed cycle... ...And so like having the strength to hold on for a founder and a funder... you want to hold on till they get very close that you could hit as much as you can, but you don't want to wait too long till you get overrun. And like, and in venture, the temptation to sort of exit early is is like so value destroying that you'd almost rather the other sin, which is like hold on a little too long. And it's a really hard thing in this business.
Segment 7: Venture as a Company & Alignment (49:04 - 50:24)
Jack Altman: Can you ask you about Brett [Berson] and his role a little bit? Josh Kopelman: Sure. So I think like, you know, when you look at like most venture firms just operate like investors. We're a group of investors that sit around a table, make investing decisions. Um, and as a result, most venture funds are very poorly run... right? Like there is no strategic planning, there's no R&D, there is no, you know, like you if Amazon deleted every customer database once a week, it would be malpractice... But like every venture firm each week gets together, has like a great IP, like their discussion, etcetera, and just walks away and like it's not cataloged anywhere, it's not learned from anywhere. So I think like what we believe as a firm is that like we want to operate like a company. We have products, we have experiments, we have like sprints and cycles, we have engineers that are building things. Um, and Brett runs all of that... And by the way, he also sits in on our investment team because being around for I guess 18 plus years, he has... Jack Altman: I mean, you also probably have to to do the other stuff well. There's probably no other way. Josh Kopelman: That's right. So I think for us, like the way we could operate as a company is to have like a CEO. Um, and and Brett basically fills that role.
Segment 8: Software Eating the World & Margin/Valuation Assumptions (35:49 - 37:18)
Josh Kopelman: ...that piece ["Why Software Is Eating the World"]... mentioned the word software 52 times. And like the basic gist of the piece was, look, software ate advertising... software ate this and it has like 90 plus percent margins, so it got software like margins. But what's interesting is while the word software appears in the piece 50 times, the word margins is just assumed and appears there once... So like the assumption is that when software eats an industry, it has superior margins. Um, and as a result, like the whole industry accepted that because it made sense, we saw it. Therefore, we expanded as an industry our aperture as to what's fundable... Like previously a clinical care company... a bank wasn't venture fundable, an insurance, a health insurance company wasn't... a sneaker company, a shoe company, a salad company, none of these companies were venture fundable before. Um, and but because the belief that software is going to eat the world, it expanded the definition. What's interesting is at least to date... you haven't seen the margins that justify the superior economics... But by and large, like the margin test hasn't played out, which is why you saw a lot of those... You're saying most industries have the same margin they always did? Even with with a with a higher R&D software expense, right? So like you saw sneaker companies building national brands, the founder did everything he expect... like you had a pair of Allbirds, I had a pair of Allbirds, it was worth $4 billion because it was valued differently. But ultimately when you value it as a shoe company, it's like 50 million today.
Segment 9: The Dot-Com Bubble Lesson on Holding (0:00 - 0:19)
Josh Kopelman: It was universally acknowledged we were in a bubble. Everybody knew it. Oh, like the Fed chair, irrational exuberance, pets.com sock puppet, like total irrationality. And if you had said, oh no, we're in a bubble, and you said I want to sell and exit now, you would have given up 83% of your profit. You would have made 17% of the total returns you could have made.
Segment 10: The Changing VC Landscape & Rise of Mega-Funds (0:25 - 1:16)
Jack Altman: I want to start with the state of venture. So you started First Round in 2004, so it's over 20 years now, which is awesome. And, um, you've seen a bunch of cycles and venture has changed like a huge amount in that time. And the lay of the land today is different than it's ever been. It's different than when I was building Lattice even, where now we've got not just like one or two big firms, but you've got like six or eight or 10 venture firms that are billions and billions of dollars. And we're not that big of an overall ecosystem in venture. And then of course you have a lot of smaller firms, but it seems categorically different because now you're hearing about firms that are playing different games than we've ever played before. And so I kind of wanted to start by just hearing your reflections of where we are as an ecosystem of venture generally around this dynamic. Josh Kopelman: It's been fascinating to watch.
Segment 11: GP vs. LP Dynamics, Growth, and the Swensen Model (1:16 - 2:27)
Josh Kopelman: So, I think we should talk about it two ways. The first way we could talk about it is how is it playing at the GP side and how's it playing at the LP side? Because at the GP side, right, in 2004, you had fewer than 850 funds. If you looked at like active check writers, people that were writing more than one check a year, probably 1,000, 2,000 people. Today, there's over 10,000 funds, you probably have over 20,000 active check writers out there. That, that's a change and I think everyone's commented on it. And and look, does it make the industry harder for VCs? Sure. Is it probably better for entrepreneurs? Yeah, more capital out there funding more ideas. I think what hasn't been talked about are these fund size changes and what that means for LPs. You know, I think when we started, uh, David Swensen pretty much like created the institutional venture asset class. He put us in business at First Round at Yale. Um, and you had like university endowments and a very select customer that basically said, we'll take illiquidity in order to get outperformance. And they really like those two matched, right? You needed to have 10 plus years illiquidity in order to get a 20 plus percent IRR and that was the deal. Jack Altman: And it happened. Josh Kopelman: And it happened, right? Like by and large, you had real good exits and it it it really created the asset class.
Segment 12: The LP Shift & "Blackstonification" of Venture (2:27 - 3:48)
Josh Kopelman: But like, I think there are a lot of smart investors out there and smart VCs and they said, you know, there's a lot of capital out there. There's capital that hasn't been able to get into this asset class. A lot of capital with like bigger purses, sovereign wealth funds, etc. And you know, they might be willing... they might have a different cost of capital. They might instead of targeting a 25% or a 4X, they might be looking at a 2X or a 12% IRR and they'll take the same illiquidity. And when you bring new investors with different capital returns expectations, it could be really transformational for the industry. So like the bull case is the Blackstonification of venture, right? You know, what Blackstone did is say it's not about alpha, it's about scale, right? If if let's let's give an example. If you had a billion dollars and it was a traditional venture fund and it could do 30% IRR, that's awesome. That's like $300 million. And if you had $100 billion fund and it could do 12% IRR, well, that's $12 billion. That's a lot more than the $300 million the first. So in terms of a total cash return from an asset under management, total profit dollars generated, like the Blackstone model won.
Segment 13: The "Venture Arrogance Score" & Fund Math (4:46 - 6:17)
Josh Kopelman: So yeah, I've spent a lot of time on it because like we, we, every three years we go out and we have to size our own fund. Um, and and so I I I've created something which I don't think I've shared publicly, but I've run inside First Round... Let's call it the Venture Arrogance Score. All right. So you take a fund. Say that fund is a $7 billion fund. Then you look and say, so you need two numbers to understand any fund's business model. First is how large is the fund? $7 billion. The next is what percent of a company do you think they'll own on exit? And so like, are they going to own 30% like they did 20 years ago? Or are they going to own 8% or 10%? And like today it's trending to 10%... So if you have a $7 billion fund and you're going to own 10% of the companies that you're in on average, you just figure out, okay, for each turn of the fund, that's $70 billion, right? Like you the founders need to create $70 billion worth of value in your basket for your 10% to be worth 7 billion. So if you want to, now if you're still aspiring for a 4X gross, 3X net, which is sort of what like the venture long-term aspirational goal was, you're now saying, okay, so for each turn of the fund, that's 70 billion, so call that $280 billion. Jack Altman: Right. Josh Kopelman: And here's where the arrogance scale comes in. Because say you raise that fund every three years, you know, that's roughly $90 billion a year of exit value that you hope to extract out of the market. Jack Altman: And how much is exiting total? Josh Kopelman: Well, the last decade was the best decade ever. $1.9 trillion total of US venture, and that includes pharma and everything, like semiconductors. So let's just include it all. Um, so that's an average of $180 billion a year. It's a median of about 100. So if you sit down and say... Jack Altman: But the outliers matter, so we'll take the average. So it's like you need to catch half. Josh Kopelman: You need to catch half. By the way, to my knowledge, there hasn't been a venture fund that has ever repeatedly caught over 10%. So you're saying that you and your fund in this hyper competitive environment with 10,000 funds and 30, 20,000 plus check writers, you are going to capture half of all venture value created every year for the three-year period in your fund just to generate that.
Segment 14: Duration Risk & Fund Models (11:30 - 12:45)
Josh Kopelman: ...duration really matters. And again, maybe it depends if you're playing the cash on cash game or the IRR game. But like, let me give two funds, okay? So the fund 10-year life size. First five years capital's called. Yep. The next five, like 1X gets done evenly over the second five, and then like there's three, 1X per year. So it's a 4X fund. 1X per year in years 8, 9 and 10. So it's a 4X fund back-end loaded in distributions. 27.5% IRR. Now let's take a same 4X fund, same 4X fund, same five-year upfront capital, same 1X that comes over the the back end, but instead of 10 years, say it's 18, not 20, but 18. Years 1 through 8, no returns. 1X returned 9 through 18, and then 1X on years 16, 17 and 18. That's a 4X, so 4X funds back-end loaded, that's an 11.5% IRR. And it's a 4X fund. So, so now you sit down and say, okay, well, like we just said, maybe they'll accept lower than a 4X, maybe they'll accept a 2X. Well, if a 4X fund over 18 years is like an 11.5% IRR, what is a 2X fund? What like, you know, I don't have my calculator, but I know it's less. Jack Altman: It's not big. Josh Kopelman: It's not big. And like maybe T-bills are a better risk adjusted investment.
Segment 15: Founder vs. VC Alignment & Secondary (13:57 - 15:08)
Jack Altman: ...founders should just want the people who have the higher returns. And I was like, and you know, I'm still fresh enough off Lattice, I'm like, why why would I want, why do I want a VC with killer returns who's going to give me a bad price and dilute me more? I want the one with the 1X, 1.5X who's happy enough to get by so that I can, you know... Josh Kopelman: So, but like, so yeah, I agree. But like Tiger and Softbank, 2020 couldn't have been more relevant. And so I think that you have a 2x2 grid of like relevancy and returns. So you could sit down and say like, if you have relevancy without returns, it's not enduring. Yep. And by the way, there are also people with very different strategies who might have returns, but the hype to substance ratio is different, right? Like if I look at like, I'm not an investor in these funds, but like if I look at Founder Collective, like from what I know, they've put up epic return fund after fund, and it's so hard to do that. I wouldn't say that they play the hype game, they play like the activity game, they're just good investors. IA Ventures, same thing. We invested with Altos in Roblox. Like under the radar, epic. And maybe like I would have put Green Oaks there except now they've kind of become more relevant because they've gotten attention, but they've been pursuing that strategy. So, so I I don't think there's any one way to play it.
Segment 16: Relevancy, Activity & Matthew Effect in Venture (15:08 - 16:31)
Jack Altman: ...that $5 billion fund probably has more relevancy. Like I think that firm, at least at a snapshot moment, probably is choosing what areas get capitalized. They're out and about, you hear more about them, they have more partners, there's more people, they're more in the mix, they're around more deals, you see them in the news more. They're choosing what areas get invested in and they're deploying dollars. And so it seems like there's something twisted about that a little bit... Josh Kopelman: ...But unlike public markets, private markets are very different. Access is highly competitive. And so founders are going to judge based on who is a really active investor, who's super connected, who has other founders in their portfolio that could be helpful, who has a lot of experience because they've deployed a lot of company adjacent, like, and so relevancy, as you define it, actually like often creates access. And to some degree, like I've long said, activity, in venture, activity begets activity. The more you write checks, the more relevant you are to other founders, the more founders refer you, the easier you have winning. There's the an effect called the Matthew effect, which is based off of some proverb in the book of Matthew where that like, you know, to those who have, more will be given. Um, and and it talks about how like compounding often happens based on like it accelerates advantages.
Segment 17: Hot Hand Fallacy in Venture (16:50 - 17:19)
Josh Kopelman: ...in sports, people talk about the hot hand, right? Right? So like, oh, when Steph Curry is like on fire and and and sinking threes, there's the hot hand, it's actually called fallacy or phenomenon because there's a debate. The hot hand fallacy is that like, oh, like because he sunk like he was three for three and threes, the next one has much better odds of going in. Like there's proof either both ways. MIT just came out and said maybe there's a little proof. But in venture, it's 100% true. And the reason why is like ultimately the reason Steph Curry makes $55 million a year is because when he shoots, he hits a lot of them. Like if Steph Curry missed all of his shots or 80% of his shots... Jack Altman: He'd get paid less. Josh Kopelman: He'd get paid less. But in venture, like if I'm a fund and I'm stroking checks, I'm just hitting three, taking three after three, you get credit for the for attempting the shot. You don't get judged on whether that shot landed, right?
Segment 18: Software Eating the World & Margin/Valuation Assumptions (34:00 - 37:18)
Jack Altman: ...the Marc Andreessen Software is Eating the World piece... which you reminded me was like written like around when I graduated from college... Josh Kopelman: Yeah, it was like, depending on when this comes out, it was probably about 5,000, literally I Googled it this morning, 5,000 days ago. So you had just graduated Princeton... What's interesting is I think that was one of the canonical pieces that shamed, like that changed almost the entire industry's framing. Like you could almost look at what was the venture industry before it? We funded software companies. And what's the venture industry after it? And um, and so many people like yourself included, anyone yourself, you know, or younger, only knows the world in which software is eating it. And to a large degree, software has eaten the world. What's in like, you know, like if you... it's massively impactful. Um, and he was right in so many dimensions. What's interesting is if you read that actual piece, um, it mentions the word software 52 times. And like the basic gist of the piece was, look, software ate advertising. Look at Google, look at Facebook. Software ate this and it has like 90 plus percent margins, so it got software like margins. But what's interesting is while the word software appears in the piece 50 times, the word margins is just assumed and appears there once. So like the assumption is that when software eats an industry, it has superior margins. Um, and as a result, like the whole industry accepted that because it made sense, we saw it. Therefore, we expanded as an industry our aperture as to what's fundable. Like previously a clinical care company, whether it's like smoking cessation, weight loss, like physical therapy, never with with human practitioners, never would have been a venture business. Uh, a bank wasn't venture fundable, an insurance, a health insurance company wasn't invest venture fundable. A sneaker company, a shoe company, a salad company, none of these companies were venture fundable before. Um, and but because the belief that software is going to eat the world, it expanded the definition. What's interesting is at least to date... you haven't seen the margins that justify the superior economics... But by and large, like the margin test hasn't played out, which is why you saw a lot of those... Jack Altman: You're saying most industries have the same margin they always did? Josh Kopelman: Even with with a with a higher R&D software expense, right? So like you saw sneaker companies building national brands, the founder did everything he expect... like you had a pair of Allbirds, I had a pair of Allbirds, it was worth $4 billion because it was valued differently. But ultimately when you value it as a shoe company, it's like 50 million today.
Segment 19: AI Impact & Potential for Margin Superiority (37:38 - 38:10)
Josh Kopelman: ...there's the AI asterisk, which is like, now finally with all of the productivity gains of AI, you might massively see margin superiority come when software eats a world. But like historically, like just when software eats... well like when the world eats software, Yeah. it hasn't, I think our assumption treated it as gospel. I know my firm did and almost every other firm, that you would get margin superiority and multiple and valuation superiority, which hasn't translated.
Segment 20: First Round's Operational Model & Brett Berson (49:04 - 51:17)
Jack Altman: Can I ask you about Brett [Berson] and his role a little bit? Josh Kopelman: Sure. So I think like, you know, when you look at like most venture firms just operate like investors. We're a group of investors that sit around a table, make investing decisions. Um, and as a result, most venture funds are very poorly run... right? Like there is no strategic planning, there's no R&D, there is no, you know, like you if Amazon deleted every customer database once a week, it would be malpractice. Their valuation would like drop in half. But like every venture firm each week gets together, has like a great IP, like their discussion, etcetera, and just walks away and like it's not cataloged anywhere, it's not learned from anywhere. So I think like what we believe as a firm is that like we want to operate like a company. We have products, we have experiments, we have like sprints and cycles, we have engineers that are building things. Um, and Brett runs all of that. And by the way, he also sits in on our investment team because being around for I guess 18 plus years, he has... Jack Altman: I mean, you also probably have to to do the other stuff well. There's probably no other way. Josh Kopelman: That's right. So I think for us, like the way we could operate as a company is to have like a CEO. Um, and and Brett basically fills that role. It's someone, like, and there's a difference between a maker schedule and a non-maker, like, right? Like, you know, you and I, founder, there's a round happening, we have to jump on it. The ability to sort of sit and think, the ability to like experiment with with products, whether it's First Round Review, whether it's our Angel Track, whether it's our product market fit method, whether it's sitting down and saying, how could we help founders like raise their next round? And what product could we build to do that? And so thinking, doing customer discovery, thinking in terms of product...
This expanded selection provides more depth on each topic, including the reasoning behind the points, the analogies used, and the conversational context.