There is a giant fight going on right now between the bulls and the bears in venture capital around the right price for the seed and series A rounds. Rounds are happening at prices that would have seemed completely insane even a year ago...

A thread

One counterintuitive concept is early stage valuations have virtually nothing to do with revenue, profits, or any traditional valuation metrics. This often drives outsiders totally crazy "A one year old startup raised at a billion with no revenue? INSANE!"

Early stage valuations are based on potential. If a fund buys 20% stakes in 20 companies that fit a certain team, market, traction and technology profile a couple of them will become so big that when they go public it will return all the capital many times over.

This portfolio construction is explicitly modeled out when a venture fund is raised as effectively a game plan for the general partners to execute on. Key assumptions are how much it costs buy a stake, how many companies to invest in and most importantly exit values.

Early stage valuations we see in the market are derived from these models. If the model says the fund will invest in series A companies and own 20% for $10m then on average the companies will be valued at $40m when they invest. Since VCs herd constantly, this distributes.

The VC firms you see investing today live by these models and their LPs expect them to do what they promised when they raised the fund. But, something big has changed...

Over the last couple years exit valuations have gone absolutely crazy. It used to be a $1-5B exit would be a solid win and most VC models were build on that assumption. But now we are seeing companies going public for $20-50B+. The models have broken...

Thus the bulls and the bears are having a huge battle. The bulls point to the models and says "if $40m pre was the right price when we expected a $5B exit then we could afford to pay 4X that now if we think we can get a $20B exit"

On the other hand the bears say "Whoa slow down, the market is clearly frothy, things are crazy and chasing unicorns is a good way to get slaughtered, these exit prices won't be sustained".

Throw in all the new capital chasing to get into venture with the great returns we are all seeing right now and this creates a pretty wild cocktail. https://twitter.com/zachcoelius/status/1345485679862509568?s=20

Thus we are seeing this giant fight all across the market as valuations have become dislocated from norms and consensus models, seemingly crazy prices are being paid. No one knows who is right. Only time will tell. But for now, expect lots more crazy high prices.