4040 Locust St.

Philadelphia, PA 19104
www.firstround.com

CONFIDENTIAL
May 5, 2015
Dear First Round Capital Limited Partner –
It is an exciting -- and scary -- time to be a venture capitalist.
In the first quarter of 2014, The Wall Street Journal began tracking venture-backed unicorns (i.e., private
companies with valuations over $1 billion) in a story called “The Billion Dollar Startup Club.” At the
time there were 42 unicorns. Just one year later, the unicorn population has more than doubled to a
total of 87 unicorns. Yes, it seems that a new unicorn was created every 9 days last year!
This is a tremendous shift in the way that startup companies get valued -- and funded. I recently wrote a
blog post about the “private IPO” phenomenon. As public market investors chase returns by investing in
private companies, they’re bringing an influx of growth capital with them, making it far easier for
companies to raise money at a unicorn valuation than to exit as one. More proof came out in a recent
CB Insights report stating that there were 9x more private IPOs (raising at least $100M) than public
offerings in 2014.
While many of these unicorns will surely prove to be tremendously valuable, enduring companies, we
believe that some of them will be exposed as nothing more than horses with sticks taped to their heads
(or as Bryce Roberts at OATV warned, “Beware of confusing donkeys in party hats for unicorns”).
This valuation inflation is not just a late-stage phenomenon either. Seed-stage valuations have increased
at a pace of over 20% YoY for the past 10 years. We predict that the market-average seed stage
valuation in 2015 will be almost 3x higher than it was when we raised our first institutional fund in 2007.
That takes what would have been a 3x fund in 2007 and makes it a 1x fund in 2015 (assuming no
increase in exit values). And it means that the seed-stage industry as whole will see a 3x decrease in
returns (again, assuming no increase in exit values) in the next several years.
We don’t have a crystal ball -- and we can’t forecast the future -- but we do have a calculator. The
simple math of venture investing says that only two numbers determine an investment’s return: the
entry price and the exit price. And while 2014 showed a slight uptick in total exit values for the industry
(mainly due to the $19B acquisition of WhatsApp), total exit values have not increased anywhere near
the pace of entry values. Indeed, the total value of M&A exits in 2013 was less than it was in 2007, and
public markets still remain relatively closed to technology companies.
Yet the money continues to flow. Limited partners committed over $4B of capital to seed-stage microVCs in the last four years, creating over 200 new micro-VC funds. That represents an almost 10x
The information contained in this letter is confidential and is intended solely for use by the limited partners of
First Round Capital, this report may not be redistributed or reproduced in whole or in part.

increase in funding levels from the prior four-years. In aggregate, it appears these limited partners (and
general partners) are making a “bet” -- specifically that exit valuations will sharply deviate from historical
averages in the coming years.
One could credibly argue that this will happen -- that the Internet is finally impacting major portions of
the population (with a billion Internet-connected smart phones) and major portions of GDP (such as
education, health care, food, transportation) -- and that this will result in companies that create
multiples of the value that prior companies did. Or, even if the current unicorns don’t experience a
“traditional exit” for many years, the increase in secondary sales will provide early shareholders with
liquidity that compensates for the lack of M&A/IPO growth.
I’m not much of a gambler, but when I’m in Vegas or Atlantic City I do play a little blackjack. And when
I sit down at the table, I know that if I play “by the book” the house has a 52% chance of winning. I’m
comfortable with those odds, and I happily sit down to play. Now say that I return to the same casino a
few months later and sit at the same table. Except this time the house has an 80% chance of winning –
and there’s no sign telling me that the odds have changed. The game is pretty different, right?
If one is aware that the odds have changed and still chooses to sit down at the table (maybe because
they have a new strategy – or they count cards), then it’s perfectly reasonable for them to continue to
play. Just like it’s perfectly fine to invest at 3x higher entry prices if you believe that exit prices will show
a corresponding (or greater) increase -- or if you believe that you are a 3x better “picker” than other
firms. That said, we worry that many investors (both VCs and LPs) are still sitting down at the
metaphorical blackjack table – and they haven’t actually figured out (or been told) that the math has
changed. And that’s a recipe for a bad night at the casino.
Our View
It’s very hard to time the market on either end of a cycle. There were investors in 1996 who believed
that the Internet “dot com” market was frothy, but if they had chosen to sit the market out (and not
invest in 1997 and 1998) they would have missed two of the best years in venture capital history.
Conversely, when the market was paralyzed with fear in 2007 and 2008 and many investors sat on the
sidelines, First Round continued to deploy capital and make new investments, adding many strong
companies to our community (like Appnexus - a recent unicorn).
However, one of the key lessons that I took away from the “dot com crash” of 2000 was that a lot of
money was lost when people (or funds) made meaningful changes to their strategy at an extreme end of
a cycle. The funds that kept their fund sizes and investment pace the same during the dot com boom
fared much better than those who chose to triple their fund size, to dramatically increase their average
check size, or to accelerate their investing pace. Indeed, there were venture firms who raised funds in
1999 that were 3x larger than their prior funds – and deployed the entire fund in 9 months.
So even though there’s almost a 10x increase in the availability of capital for seed-stage funds right now,
we’ve chosen not to materially increase our fund size (our current fund is just 2.8% larger than our prior
fund). And while there has been a 4x increase in the number of companies getting seed funding, we
The information contained in this letter is confidential and is intended solely for use by the limited partners of
First Round Capital, this report may not be redistributed or reproduced in whole or in part.

haven’t increased our pace. We believe that great companies emerge during both boom times and bust
times – and that sticking to our investment model (and strategy) is especially important during both ends
of the cycle.
History has shown that great funds can consistently produce great returns even during a poor market
environment. We recognize that we’re not immune to market returns. And we’re aware that higher
entry prices (which we’ve been paying) will make it harder to generate the returns that we (and you)
expect without an increase in exit prices. However, given the larger size of our fund relative to other
seed stage investors, our experience investing through bull and bear markets, the power of our brand
and our unique focus on building a differentiated platform and community – we believe that we’re
among the best positioned seed-stage firms to succeed in a tough market.
Finally, we think that there’s real power in understanding the math of the market. I believe that many of
the new crop of seed investors may not be aware of the “bet” they’re making – they’re not explicitly
focused on the new math that results from increasing entry prices. We are. We understand that our
conviction in our decisions needs to be meaningfully higher in order to invest at meaningfully higher
valuations. And we’ve spent many years working to distinguish ourselves in an increasingly crowded
market.
The First Quarter
While we continue to deploy capital and invest in new companies, we’ve thoughtfully slowed our pace.
During the last two quarters (Q4 2014 and Q1 2015), we funded a total of ten new investments. This is
our slowest two-quarter period in six years (i.e., since Q4 2008 and Q1 2009). We don’t expect that
our pace will permanently remain this low – already one month into Q2, we’ve seen an uptick in new
investments.
We believe that great companies can be started in any market, and we have tried to remain disciplined
(in an undisciplined market) and focused on the two numbers that matter: entry price and exit price.
Fund Performance
We moved to a new LP reporting format this quarter. Rather than send a separate letter for each fund
you’re invested in, we’ve chosen to write this one letter to highlight some thoughts on the market -and to provide a “Fund Scorecard” for each fund.
The Scorecards contain Gross and Net fund performance, as well as a summary of the publicly reported
quarterly activity in each fund. While we are happy with (most of) our funds’ performances, we want to
stress that most of the valuation increases are “unrealized”, and until these companies end up in the
“realized” column (through IPO, M&A or secondary sales) the valuations are just paper increases. Our
valuation policy requires us to value our portfolio companies based on market prices – and in today’s
market we are seeing companies raise follow-on financing rounds at much higher prices than we have
seen before. Past experience has shown that valuations can change significantly over time – and despite

The information contained in this letter is confidential and is intended solely for use by the limited partners of
First Round Capital, this report may not be redistributed or reproduced in whole or in part.

our best efforts, we expect that several of our portfolio companies will end up being marked
down over time (with many potentially being written off entirely).

As always, if you have any questions or require any additional information, please don’t hesitate to
contact me.
Best regards,

Josh Kopelman

The information contained in this letter is confidential and is intended solely for use by the limited partners of
First Round Capital, this report may not be redistributed or reproduced in whole or in part.