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The public markets are deep crimson. The last time VC sentiment was so publicly negative, Twitter turned two. Term sheet re-trading rumors have surfaced.

Public markets do impact startup fortunes, but only inasmuch as the prices at which venture rounds clear. IT spend is the more important canary in the coal mine.

If customers cut their software spend, startups should expect a harsher climate.

AngelList published their quarterly state of venture report. I wrote down five data points that struck me:

1. Q1 2022 was the most active quarter ever in Angellist history, and likely venture history. The term sheets signed in November and December closed in Q1, which may buoy these figures. In addition, late-stage investors moving into the seed stage market also buttress these stats.
2. 83% of rounds in Q1 were up-rounds, which is statistically identical to Q4. late-stage market prices have declined about 30%. No parallel compression exists in the early-stage market, yet.
3. Startup valuations. The 75th percentile of Seed startups raises at 30m valuation and Series A at $100m. Seed has become the new A. $100m post is consistent with what I’ve seen in the market for the most sought-after investments. Some raised a seed first; others particularly in infrastructure decide to go straight to A.
4. 65% of seeds choose to raise capital via SAFE, a form of debt, rather than an equity round. If Seed is the new Series A, then this implies a meaningful change. Most SAFEs forgo a board-of-directors. A decade ago, businesses raising $3-5m Series As would elect a board. This data point confirms founders have maintained leverage in fundraising conversations.
5. Web3 deals represented more than 11% of investments, the largest share, superseding fintech and healthcare. Web3 is a term that will disappear like web2 and mobile investing before it. It encapsulates software, infrastructure, and consumer services- unlike the other buckets which are more narrow. While the segmentation may skew the data somewhat, the data point does underscore investor interest in the category broadly.

The Q4 charts may not differ much from those published in this report. Web3 will remain a top area of interest. SAFEs should persist as a dominant form of financing early-stage startups, and consequently inform board construction. Perhaps valuations and activity will change, but given the amount of capital in the ecosystem, the magnitude might be muted.

A founder recently told me he would have built his company differently in another fundraising market.

When I asked him what he meant, he replied because capital was so plentiful and accessible today, he hired more expensive people, spent more time developing a product, and invested with a longer time horizon before demonstrating evidence of success.

In my notebook, I sketched this 2x2. Capital availability on the x-axis and evidence on the y-axis to illustrate his point.

When I hosted this blog on Amazon Web Services, I used 5 products. I paid for them each in US dollars every month. One invoice.

Suppose I wanted to rebuild my site on web3 using fully decentralized components. I would pay each product provider in their own token: one for storage, compute, caching/CDN, email subscription management, etc. Tokens reward the validators and the stakers powering the decentralized networks.

Paying five decentralized providers in five different tokens means managing several wallets and monitoring token prices to hedge expenses. That’s much more work than the automatic credit card payment with AWS. It’s too much complexity for a simple static blog.

I used to have a clear answer to a founder’s question, “How do you value a company?” The question is just as important in conversations within a VC partnership as with founders. A valuation must have some justification to be compelling.

Reflecting on this question a founder posed this week, I remembered how we came to be here, the three eras of startup pricing: cash-flow, multiples, and discount-to-future-value.

Cash Flow
In the aftermath of the dotcom crash, a valuation depression kept valuations low. A few months before Lehman fell, I joined Redpoint. I was taught to ask founders how much capital they needed to attain milestones and circumspect the financial model. How much money did the company need to have 18-24 months of runway? The model says $4m? Great.

Imagine you’re a venture investor. You find a great company. You buy 16% of the company for $8m at $50m post-money valuation. Six months later, the company raises $100m at $500m. Things have gone very well.

Your 8m has 10xed. Naturally, you ride an imaginary horse around the room, galloping with glee.

Now you face an important strategic question: Do you invest your full pro-rata of $16m? Pro-rata is the right to invest more to maintain their percentage ownership. Venture firms reserve capital for these financings.

Defi lending protocols, distributed exchange protocols, cross-chain messaging protocols, communication protocols. All of them are in the process of being invented, debated, and adopted.

In a roundabout way, this post is about the emergence of web3 protocols. But it’s about how we got here.

For 20 years, from 1970 to 1990s, the first Protocol Wars raged over clacking IBM Model M mechanical keyboards.

At the time, computers were connected by local networks. Stanford operated a computer network. DARPA and University College London also. But these networks couldn’t talk to each other in a standardized way - paralleling the limited interoperability of blockchains today.

Revenue, Revenue_USD, Revenue_new, rev2, customer_revenue. Do you recognize these? They might be the column names you might find in your BI or analytics tool. Which is the one to use?

You pick Revenue_new (it’s new, after all!) and proceed with your analysis. A few minutes into the meeting with the sales team, the group startles: the data doesn’t match their expectations.

Something’s wrong.

What data are you using?! Revenue_new? Oh, Revenue_new is the old column. The company moved to customer_revenue last quarter when we hired a new VP of Finance and they updated the definition.

Traditional software was initially sold by perpetual license. Then in the mid-00s with the advent of SaaS, the market shifted to per seat per year pricing. And simultaneously, freemium marketing strategies blossomed. Freemium companies provide software for free temporarily to entice users to try and use the product. Eventually, these users cross a threshold and convert to a paid subscriber. This threshold can be based on number of people using the product (Expensify), number of documents signed in a month (HelloSign), or additional product features needed by users (Yammer).

As I’ve explored web3 I’ve been forming a mental model of the major innovations powering this enormous wave of innovation. At the moment, I see four clusters:

1. A permanent ownership record that exists beyond and outside a company. The photos I take, the movies I buy, the music I rent, the emails I write and receive, the messages I send - all of these are captive. They exist within a database controlled by Google, Netflix, Spotify, Gmail, WhatsApp. If these services disappear, so does my ownership/rentership record. In a future where digital assets are worth not $10 or $20, but hundreds or thousands of dollars, ownership that survives a company becomes an essential substrate of commerce.
2. Paying customers in “equity.” Internet hegemons have decimated entire spaces: social networks, advertising technology, video streaming and rental, paid email, infrastructure. Their economies of scale and network effects mount significant barriers to competition. What’s a startup to do? Compete on a different axis: reward users with tokens. A social network rewards its most valuable users in the coin of the realm. Same for music or file storage or graphics processing. As the network becomes more valuable, so does the user’s stake in the company. Web3 companies employ tokens to reward their customers for providing value. Because this technique is so new, startups have the upper hand: Innovator’s Dilemma redux.
3. Regulatory arbitrage. Twenty years ago, startups IPOed after 4 years. Today, it’s 12, driven by several factors but regulatory costs present the principal one. Crypto companies access pools of capital web2 companies cannot because the regulation doesn’t exist. Where nascent rules are present, the regulation isn’t yet a warren of legalese- yet. Within this freedom to maneuver, Defi protocols invent new financial instruments. The perp, a perpetual swap, has become the most traded crypto derivative). Perps don’t exist outside crypto.
4. DAO/Foundations: open-source software is arguably the most important motive force powering innovation in technology. Open-source software powers every server and most software. Crypto empowers open-source projects to monetize their innovation in a way web2 never achieved. DAOs bind the loose community of open-source software contributors through tokens. Tokens provide an ongoing financial link that aligns long-term incentives. Foundations endowed with significant token stakes fuel the ongoing protocol development, balancing the capitalism needed to fuel progress with the benevolence intrinsic to the open-source ethos.

But, wait. There’s one more!