The End of Venture's Free Lunch
AI as the catalyst that will take venture back to its roots of truly disruptive innovation
I’ve long argued that much of the last 20 years in venture, especially in B2B SaaS, was a bit of a free lunch for investors. Investors in the space earned venture returns for taking growth equity risks (more on that below). With AI quickly eating away at that free lunch, we’re at an inflection point where the best venture returns will come from teams that create valuable intangible assets and exploit those assets to create new capabilities.
To understand what I mean when I say investors “earned venture returns for taking growth equity risks”, I need to share a bit of background. A decade ago, I started as an Investment Analyst at the Cornell University endowment. I invested across multiple asset classes but spent a majority of my years there investing in venture, growth equity, and buyouts. I met hundreds of world-class GPs and saw first hand the core drivers of return across each sub-asset class, specifically:
Buyouts: Free cash flow, leverage, margin expansion, and multiple expansion from broad market sentiment
Growth Equity: Top-line revenue growth, multiple expansion from broad market sentiment
Venture Capital: Intangible Assets, specifically human capital and/or intellectual property
For a long time, investing in a software business doing a little revenue but growing top line fast was what most VCs wanted to see. Revenue and growth hurdles were largely consensus, and valuations from round to round were fairly range bound (at least until 2021…). If a company grew revenue, its valuation went up commensurate with that. Everyone knew where the goalposts were. Product, sales, product, sales, on repeat. Sam Lessin at Slow Ventures calls this the Unicorn Factory System of venture. I agree with Sam that this model of venture is dead. But for a while, it REALLY worked!
In this new reality where AI eats software returns, venture investors need to be asking themselves “Is this company creating extremely valuable intangible assets?” Revenue growth, potential for strong free cash flow generation, and high valuation multiples are all downstream of that, but at the earliest stages, a VCs job is to catalyze intangible assets that serve as the basis for incredible unit economics in the future.
There’s no more free lunch, which will make the next decade-plus incredibly fun for those willing to take the big swings necessary to build generational companies.