20VC: To Win in AI, Investors Need to Change Their Approach
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Host: Nabeel Hyatt, GP @ Spark Capital
Q1: How is the mindset shift in investing, particularly in the new world of AI, perceived? What changes are necessary for investors to adapt to this evolving landscape?
Nabeel Hyatt believes this shift is already happening, whether we like it or not. They emphasize that we can't preach that a founder is supposed to adapt to a market and understand that the market is there without doing the same ourselves. Nabeel Hyatt introduces the concepts of "founder market fit" and "VC market fit," suggesting that venture capitalists also need to adapt to changing market conditions. The industry is experiencing a significant transformation, and the question now is in what way it's different.
Q2: In transitioning from a world of puzzles to one filled with mysteries, how should investment strategies be adjusted? What are the key differences in approach required for this shift?
Nabeel Hyatt draws a distinction between puzzles and mysteries in investing. Puzzles are problems that can be solved with raw horsepower, while mysteries require going on a journey with fog of war, where outcomes can't be predetermined. The B2B SaaS boom of 2021 was characterized by the industrialization of venture capital, focusing on solving puzzles by hiring numerous associates to figure out the right SaaS metrics. However, in the current AI-driven landscape, no one can predict what a model will do in a week, making it more of a mystery. Nabeel Hyatt suggests that firms need to build a set of talent capable of navigating these mysteries. They acknowledge the challenge of this shift, noting that the world was turned upside down by DeepSeek, and similar disruptions are likely to occur every few months.
Q3: How are venture firms adapting to the new reality of the AI-driven market? What strategies are they employing to stay relevant and competitive?
Nabeel Hyatt believes most venture firms are not adapting adequately. They point out that the evolution cycle in VC is extremely slow, partly due to the involvement of Limited Partners (LPs). VCs can't act independently; they need to raise another fund against a new mandate, which might require turning over half to three-quarters of the team. This presents a challenge because what's right for the firm may lead to bad messaging to LPs, who find instability disconcerting.
Q4: What steps should venture firms take to reshape themselves for the new world of startups? How can they align their strategies with the evolving startup ecosystem?
Nabeel Hyatt suggests that firms need to be comfortable with small teams making subjective bets. They emphasize the importance of understanding the craft of what founders need today, which is different from what was needed four years ago. Previously, founders needed playbooks and simple ways to make everything move faster. Now, the conversations with founders are about unknowables. Nabeel Hyatt advocates for a return to a more artisanal approach to venture capital, similar to the early days of firms like Sequoia. They argue that the industry is moving away from the era of late-stage capitalism for startups, which was focused on optimization and minor arbitrages, towards a world that requires rampant creativity within organizations.
Q5: How does Nabeel Hyatt's experience in venture capital inform their perspective on the changes occurring within the industry? What insights do they offer based on their background?
Nabeel Hyatt has been a VC for a little over 10 years and was a founder before that. They draw on this experience to compare the current shift to the early stages of venture capital, describing it as a return to dealing with mysteries rather than puzzles. They argue that the successful companies of the recent era (like Ramp or Brex) followed a predictable pattern: serial founder, pedigree founder, good big market, knowable go-to-market strategy. However, they suggest that firms that built strategies to dominate the world 4 years ago might be in trouble without completely changing their approach.
Q6: What challenges do venture firms face in adapting to the new landscape of AI and technology-driven investments? How are these challenges being addressed?
Nabeel Hyatt highlights the tension between the need for rapid change and the desire for stability from Limited Partners (LPs). They point out that LPs find instability very disconcerting, which can be a red mark against a firm. This creates a dilemma where what's right for the firm in terms of adapting to the new landscape may lead to bad messaging to LPs. Nabeel Hyatt also questions whether the decision-makers at VC firms, who may have benefited from the B2B SaaS boom of a few years ago, are truly willing to make the necessary changes. They suggest that reshaping a firm for this new age may require drastic changes, including potentially turning over a significant portion of the team, which can be challenging to justify to LPs in the short term.
Q7: What are companies trying to figure out regarding new user experiences with multimodal models? How are they approaching the integration of these models into their offerings?
Companies are exploring new user experiences as models become multimodal. They are seeking guidance and using board members as sounding boards who actively use their products and have curiosity about other AI products. These companies are not necessarily looking for definitive answers, but rather seeking insights from those who are actively engaged with AI technologies beyond just monitoring social media trends.
Q8: How has AI impacted traditional investment heuristics, particularly concerning revenue? What changes have been observed in the evaluation criteria for investments?
AI has significantly disrupted traditional investment heuristics. Previously, a common benchmark was reaching $10M in Annual Recurring Revenue (ARR) within 18 months. However, AI products are now achieving $10M ARR in just a couple of months. Interviewee suggests that these rapidly growing products might become obsolete within two years. Nabeel Hyatt also questions the validity of using revenue as a primary heuristic for quality assessment in the AI sector.
Q9: Why have simple heuristics like revenue targets become prevalent in venture capital decision-making? What advantages do they offer in the current investment climate?
Simple heuristics like revenue targets have become prevalent because they provide easily measurable goals for venture capital firms. These metrics, such as reaching $10M in revenue or achieving certain dashboard indicators, are used to gain partnership approval for investments. However, Nabeel Hyatt suggests that these simplistic measures may not be the most effective way to evaluate AI companies and their potential.
Q10: How has the structure of venture capital firms changed, and what impact does this have on investment decisions? What are the implications of these structural changes?
The structure of venture capital firms has evolved from having a small number of partners (around 7) to much larger teams with 25-30 partners, or even up to 500 partners in some firms. This expansion has led to an industry now largely run by principals, associates, and junior general partners (GPs). This shift in structure has created a new incentive system that didn't exist 20 years ago. Principals are primarily motivated by career advancement rather than waiting for exits. They aim for promotions or opportunities to move to more prestigious firms within a short timeframe, typically around two years.
Q11: How does the career motivation of principals in VC firms affect investment strategies? What influence do personal goals have on the decision-making process?
Principals in VC firms are primarily motivated by career advancement rather than waiting for investment exits. They seek promotions or opportunities to move to more prestigious firms within a short timeframe, typically around two years. This motivation leads to a focus on quick "markups" in valuations. Principals often invest in companies slightly earlier than the next funding stage, aiming to get a markup within a few months to enhance their own career prospects. This approach has become prevalent in the industry, with investments often being packaged and passed on to the next stage of investors quickly.
Q12: What are the potential drawbacks of the current VC investment approach focused on quick markups? How might this strategy impact long-term success?
Nabeel Hyatt expresses strong disapproval of the current investment approach focused on quick markups. While acknowledging its prevalence this strategy is not beneficial for startups or founders. More importantly, it's considered a losing strategy in a rapidly evolving tech landscape where predicting the next hot trend 9 months in advance is challenging without deep involvement in the work. Nabeel Hyatt advocates for a winning strategy of backing exceptional founders with unique insights and taking a long-term approach, despite the difficulty in executing this simple-sounding but challenging strategy.
Q13: How does Nabeel Hyatt view the use of simple heuristics in evaluating the increased number of startups? What are the benefits and limitations of this approach?
Nabeel Hyatt acknowledges the explosion in the number of startups, which has created a need for simple heuristics to quickly assess whether a company is worth meeting. However, they argue that merely adding more principals and associates to VC firms doesn't effectively solve this problem. Nabeel Hyatt points out that while there has been a hundredfold increase in the number of startups, firms have only added a few more principals, suggesting that this approach is insufficient to properly evaluate the vastly expanded startup landscape.
Q14: Is pattern matching possible in the current market environment? What factors influence the ability to identify successful investment opportunities?
Nabeel Hyatt believes that the "Brita filter version of investing" is not the right approach for evaluating investments or executing their job. This approach, which involves taking in all founders at the top and filtering out a handful of good ones at the bottom, is seen as an inbound, inbox-oriented view of the world. It requires extensive tweeting, marketing, and quickly processing a large amount of inbound opportunities in a transactional manner. Nabeel Hyatt prefers a different approach that doesn't focus on winning the coverage game or rapidly moving through a funnel to say no quickly.
Q15: How did Spark Capital's approach to investing evolve from the early Web 2.0 era to the present? What lessons were learned from this evolution?
Spark Capital was started in the early Web 2.0 era, alongside firms like USV and Benchmark 2.0 (the beginning of the Gurley era). These firms navigated the mobile era well, which was characterized by uncertainty in metrics and a wide-open, crazy world where investors might look at a "fart app" in the morning and Uber in the afternoon. Nabeel Hyatt admits that Spark may not have navigated the B2B SaaS era as effectively as some peer firms 4-5 years ago. Unlike other successful firms, Spark chose not to raise $5B or significantly expand their team. They maintained their approach of having all partners write checks and work directly with founders, which made their job harder 4-5 years ago but positions them well for the current phase.
Q16: Do you agree with Doug Leone's assessment that venture capital has transitioned from a high-margin boutique industry to a low-margin commoditized one? What evidence supports this view?
Nabeel Hyatt is hesitant to disagree with Doug Leone but notes that Sequoia is executing a strategy as if that assessment is true while trying to maintain a compact and authentic approach. Nabeel Hyatt argues that when looking back at the current era, it may not feel like a low-margin commoditized industry. This is because many firms are executing strategies that may not be particularly effective in the current market, meaning competition is actually limited to a smaller subsegment of investors on any given deal. Nabeel Hyatt mentions losing only two deals in 24 months where competitors significantly increased the price and offered common stock. While acknowledging a list of FOMO deals where prices became insane, Nabeel Hyatt rejects the notion that the hottest deals don't turn out to be the best, suggesting that this is precisely the nature of the venture capital industry.
Q17: How is investing approached in companies that are "one of many" in their industry? What criteria are used to identify potential winners in crowded markets?
Nabeel Hyatt emphasizes the importance of a company having a competitive barrier to entry or a reason to become a lasting institution. When considering investments, especially for larger growth checks, they focus on companies that have the potential to become public, long-lasting institutions decades from now. This requires believing that the company has some enduring value that will persist for a long time. If a company doesn't appear to have a competitive edge, even if it's in a profitable industry with multiple successful players, it becomes a challenging investment proposition. Nabeel Hyatt stresses the need to build a firm and be comfortable with the idea that there will always be exceptions to previous knowledge, as this is inherent to the nature of venture capital.
Q18: Can operations be sustained in markets where companies can be turned upside down overnight? What strategies are employed to manage such volatility?
Interviewee doesn't think so. The company operates an early-stage fund and a growth fund. The early-stage fund is a little over $700M, and the growth fund is double that size. It's not small for an early fund, with 7 partners. Nabeel Hyatt emphasizes that it's not about writing small checks, but being subjective and coming from first principles in investing. Spending time setting up checklists or working on organizational politics takes away from evaluating the fundamental truth of whether a set of founders with an amazing idea will turn into something significant.
Q19: How can politics be removed from venture capital? What measures can be implemented to ensure objective decision-making?
Nabeel Hyatt acknowledges that venture capital is often considered to have the most politics per human inside of almost any organization. This is because all measurements before exit are essentially false profits. Until capital is returned and an enduring institution is created, it's all just games and packaging. Nabeel Hyatt suggests starting with respect and focusing on self-actualization rather than trying to be a mini-me version of other partners. The biggest mistake Nabeel Hyatt made was trying to be like a former partner instead of being their best self. Mentorship should focus on getting to know another person, figuring out their superpowers, and understanding how they'll be the best partner to a founder. A lot of venture capital is about falling in love with founders and their ideas.
Q20: How is the performance of team members in venture capital evaluated and improved? What metrics and feedback mechanisms are used?
Nabeel Hyatt emphasizes the importance of honest feedback and self-awareness. They use the phrase "being your brother's or sister's keeper" internally. The team feels that debate is not a political fight to get something approved, but a search for truth. Partners often know each other better than they know themselves. After 3-6 months, they start noticing patterns in investing, weaknesses, and the types of bad deals team members fall in love with. Nabeel Hyatt values this team approach, stating they wouldn't want to do this job alone.
Q21: When did self-doubt most affect Nabeel Hyatt as an investor? What lessons were learned from these experiences?
Nabeel Hyatt mentions the COVID era as the most challenging time. It represented the worst version of venture capital, pushing everything to Zoom calls. Nabeel Hyatt values in-person connections, making eye contact, and being in service with founders, which became difficult during this period. During this time, while many were making rapid investments, Nabeel Hyatt wrote the fewest checks in their career, only about 2 checks in a year and a half. They believe the quality of early-stage investing went down during this period but has since recovered. The growth team, however, navigated the situation quite well.
Q22: Why do early-stage and growth-stage investing require different teams? What are the distinct skill sets needed for each stage?
Nabeel Hyatt observes that early-stage and growth-stage investing are different "sports" or "animals." The growth team can have principles and associates, conduct more diligence, look at numbers, and call numerous customers. In contrast, early-stage investing often involves companies without many customers, making it a different process and requiring a different muscle. While Nabeel Hyatt doesn't claim they couldn't do both, they question why they would try to play two sports when excelling at one is already incredibly challenging. They use the analogy of trying to beat Michael Jordan in both basketball and baseball. Nabeel Hyatt acknowledges that some argue becoming a better early-stage investor with a late-stage mindset is beneficial, as it provides insight into what later-stage investors want. However, they caution against spending too much time internalizing what public markets are thinking about in the short term, especially when considering long-term investments in sectors like AI.
Q23: What is the opinion on VC armchair investors who focus on macro trends? How does this perspective influence investment decisions?
Interviewee hopes that the cycle comes back around for them in exactly 7 to 10 years when those companies want to go public, and if it does, they'll succeed. Nabeel Hyatt notes that the word "service" was mentioned several times, and references Keith Rabois' public statement that the best founders don't need the help of a VC.
Q24: Do you agree with Keith Rabois' statement, and how is it viewed in relation to the concept of service? What are the implications of this viewpoint?
Interviewee raised 8 rounds of venture capital as a founder and never had a horror story from a VC. Nabeel Hyatt mostly had VCs that were fine, falling into the Keith Rabois camp. They would show up to board meetings, and it was fine, allowing Nabeel Hyatt to just run the company. Nabeel Hyatt then questions this approach, imagining that in any other context of life, if someone on their team was just "fine," what would be the feedback?
Q25: How would "fine" performance be compared in other contexts? What benchmarks are used to assess success?
In the context of marriage, being just "fine" would be disastrous. Nabeel Hyatt questions why we accept mediocrity at the VC level, stating that if an executive assistant, VP of engineering, or head of product was just "fine," it wouldn't be acceptable. Nabeel Hyatt argues that we shouldn't accept mediocrity at that level.
Q26: What qualities should investors ideally possess? How do these traits contribute to effective investment strategies?
Nabeel Hyatt believes investors should be engaged, look at the details, be emotionally invested, want you to win, and do the detail work. They should not just give armchair VC advice from their one board meeting with another hot company. Every startup is a different journey, and until you get under the covers of what's really going on inside the organization (e.g., how co-founders fight, problems inside the executive team), you can't give proper advice. Understanding these details allows for different, more tailored advice. Nabeel Hyatt acknowledges that if you can't find an amazing, deeply engaged VC who will use your product, then opting for a "no op" VC who at least does no harm is understandable. However, Nabeel Hyatt argues that mediocrity shouldn't be the goal. The goal should be to have investors, employees, or anyone in your orbit as a founder who is obsessed with your mission and tries to help you.
Q27: Can this level of engagement be achieved at scale? How many investments are typically made per year to maintain such involvement?Nabeel Hyatt makes 2 to 4 checks at most per year, but typically 2. They acknowledge that this model can't be done at a larger scale.
Q28: How are situations handled where faith in the founders is lost? What steps are taken to address these challenges?
Nabeel Hyatt hopes to have many conversations before reaching that point. They emphasize that being dedicated or loyal to a founder doesn't preclude tough love. Using the marriage analogy that if you're just smiling all the way through a marriage, you're not executing it correctly. Sometimes tough conversations are necessary when you feel a person has lost their way.
Q29: When founders have lost their way, what was missed in the initial assessment? How can these oversights be prevented in the future
Nabeel Hyatt identifies two main reasons things haven't gone well. First, founders being conflict-avoidant, which is hard to detect early on when relationships are positive. It becomes apparent when the company faces numerous conflicts in its early months, and the founder isn't addressing these problems. The second reason relates to the balance between execution speed and taste/judgment. Nabeel Hyatt explains that while they want founders who can move fast, they also need to have taste and judgment, especially in the world of AI. The ideal founder needs to match the opportunity of the startup, having both good taste and the ability to move quickly.
Q30: Where on the spectrum of competitiveness should a company be for investment consideration, particularly in a highly competitive market with numerous players? What factors are evaluated?
For a highly competitive market with many players, it becomes an execution play. The founder needs to be in the top 0.0005 percent on the planet in terms of execution ability. The roadmap is likely clear, or competitors are about to implement it soon. The key is to run faster than competitors and aggregate innovations happening across all 25 competitors to win. However, at Spark, we often deal with situations where we're creating a new market that didn't exist before. This requires incredible taste. Some founders might build a "me too" product with slight arbitrage, perhaps slightly faster or with minor improvements, and try to outpace competitors. But creating a new market demands a different approach.
Q31: How is a founder's ability to navigate between execution and innovation evaluated, especially in a competitive market? What criteria are used to assess this balance?
The best founders can manage and understand which muscle they're using at any given moment. For example, Chris, one of our investments, completely changed his product from the seed round to the Series A, which we led. Even though internal metrics were okay, he realized it wasn't working and made a reset. This demonstrates real taste. He's in a competitive market and needs to be high on the execution path as well. It's a hard combination of both execution and innovation. Mistakes often occur when founders are misjudged on one of these axes, or when the market suddenly flips. For instance, you might have invested in someone who's very execution-oriented with a good amount of taste, but then the market changes dramatically.
Q32: How is the sustainability of value assessed in such a rapidly changing world, especially with the potential for disruptive technologies to emerge overnight? What strategies are employed?
In this rapidly changing environment, you need to find a founder who is continually innovating. While you can ask simple questions about barriers to entry and have decent answers, the truth is that if you're not reinventing yourself, you're at risk. Take DeepSeek as an example - it shows that traditional notions of barriers to entry may not apply. You have to justify your investment to yourself, perhaps by having a base case for the near term. For instance, you might think about how their 2026 will be good, or hope for some compounding effect that will sustain the business beyond 2025. However, the days of launching a product that remains essentially unchanged for decades (like eBay) are largely gone. In the AI space, it's currently a sea of speed and taste simultaneously. Market creation is crucial, and at Spark, we don't focus much on market size unless it's clearly a small market. We're not trying to canvas the entire world for every possible investment opportunity. Our goal is to do a good deal a year, partnering with founders who align with our approach and looking for new market opportunities, which are abundant in the world of AI.
Q33: Why is there a focus on aspects that are so transient in AI investing? With market, people, and product as core areas, do we truly understand any of these markets in the world of AI, and how rapidly are they changing?
Nabeel Hyatt acknowledges the transient nature of markets in AI, noting that a big market two years ago might become a small market now, or vice versa. Regarding people some firms excel at making bets on individuals. They suggest that investors develop an instinct about people that helps them make decisions. As for product, Nabeel Hyatt views it as a manifestation of the founder's capabilities rather than being a product master themselves. Nabeel Hyatt reframes the approach to separate hucksters from good executors by examining what the team has created and asking questions about their decisions. This method provides insight into the individuals behind the product and their potential future actions.
Q34: How are CEOs and product leaders in AI companies evaluated? What qualities are sought in these leaders?
Nabeel Hyatt mentions having a CEO template for analysis but emphasizes that applying the same template to a Chief Product Officer (CPO) would be inappropriate. Instead, they've modified their approach for product leaders, asking questions like: "What product decision are you most proud of?", "What would you most like to build but can't due to constraints?", and "What are you most embarrassed about building?". Nabeel Hyatt clarifies that the specific answers matter less than how the person thinks about their work. They're not looking for rehearsed responses about Total Addressable Market (TAM) or margins, but rather trying to understand how the individual thinks about the things they're doing.
Q35: In evaluating early-stage AI startups, what aspects are focused on most? What criteria are prioritized in the assessment process?
Nabeel Hyatt suggests that for early-stage startups, it's crucial to focus on what the founders have thought about the most. They point out that TAM slides or other deck elements might only represent a few hours of work, or could even be generated by AI tools like GPT. Instead, they believe the product the startup has created is where the founders have spent the most time thinking and working. Therefore, examining the product and asking questions about the decisions made in its development provides the most insight into who the founders are as individuals and what they're likely to do in the future.
Q36: How many AI companies are typically met with in a week, and what is the preferred meeting format? What approaches are used to efficiently evaluate these opportunities?
Nabeel Hyatt mentions that while they might encounter 20 to 30 companies a week via email, they typically have calls with only 1 to 2 companies per day. Regarding meeting format, they express a preference for either short 30-minute calls or longer 2-hour sessions, rather than 1-hour calls. Nabeel Hyatt explains that a 30-minute call is used to determine if they like the person and want to have a second call. They find 1-hour calls ineffective, being too short for a comprehensive understanding but too long for a quick assessment. Their strategy is to start with a brief call to get an initial read, then potentially move to a more in-depth 2-hour meeting if interested.
Q37: Will investments ever be made without meeting the founders in person? What factors influence this decision?
Nabeel Hyatt stated that they probably would not invest without meeting the founders in person. However, there are exceptions. For instance, if Nabeel Hyatt had met the founders 5 years ago and knew them quite well, they might consider investing. Nabeel Hyatt provided examples of long-term relationships leading to investments, such as Chris from Granola, who was a prior Spark founder, and Jason from Discord, whom Nabeel Hyatt knew for 7 years before investing. Nabeel Hyatt also mentioned cases where they initially passed on investments but later reconsidered after spending time with the founders, like with Cruise and Kyle. In competitive situations, such as with Wordware, Nabeel Hyatt met with the founders 6-7 times within a week before investing, emphasizing the importance of personal interactions even in fast-paced scenarios.
Q38: How price-sensitive is the approach to investing? What considerations are made regarding valuation and cost?
Nabeel Hyatt stated that they are not very price sensitive. However, they acknowledged that there is always a point where the price no longer makes economic sense. Nabeel Hyatt views valuation as a test of conviction. They explained that if they liked a company at a $60 million valuation but not at $65 million, it wouldn't make much sense. However, if the valuation jumps from $60 million to $100 million, that would be a different scenario. Nabeel Hyatt emphasized that the difference between $60 million and $80 million, or $80 million and $100 million, is not significant enough to deter investment if they believe in the company. For their fund, which has a small number of investors (6) managing a $700M fund, the issue is often more about check size than valuation. Nabeel Hyatt explained that they consider whether writing a $5M, $10M, $15M, or $20M check is appropriate based on the company's stage and ability to effectively use the capital.
Q39: What investment opportunity was turned down due to price that is most regretted? What lessons were learned from this decision?
Nabeel Hyatt mentioned Figma as the investment opportunity they most regret turning down due to price. It was still pre-launch, and the decision involved writing a very large check before the product was released. Nabeel Hyatt expressed that beyond the high valuation, there was a strong connection with Dylan, the founder. They believe that journey would have been fruitful, interesting, and an amazing way to spend 5 to 10 years of their life. Nabeel Hyatt also discussed the risks of over-capitalization, stating that too much capital can potentially harm a company. They gave an example of how a company raising an additional $100 million might eventually fail, taking a long time due to the excess capital but increasing their probability of failure. Nabeel Hyatt suggested that in such scenarios, investors can monitor hiring velocity, quality of hires, and execution speed to identify potential issues and consider investing in alternative opportunities in the market.
Q40: When advising companies not to raise a funding round, do they listen? Is there active engagement in secondary markets?
Interviewee stated that companies generally do not listen when advised against raising a round. Regarding secondary markets, Nabeel Hyatt explained that with the significant influx of private late-stage capital and continuing delays in public markets, there is a need for liquidity. At some point, investors need to deliver cash returns, including Nabeel Hyatt.
Q41: Are secondary markets becoming an increasingly important part of the venture capital role? What trends are influencing this shift
Nabeel Hyatt clarified that they are not saying secondary sales never happen or should never occur. However, they emphasized that the primary job of a venture capitalist is to try to envision the future, listen to founders with innovative ideas, and maintain an open mind to shift perspectives when presented with unconventional concepts. This process requires time, energy, research, trying every product, and maintaining curiosity.
Q42: How is time and energy allocated as a venture capitalist? What priorities guide this allocation?
Nabeel Hyatt acknowledged that secondary transactions, later-stage valuations, growth investing, and organizing conferences are all possible activities for venture capitalists. However, they stressed that excelling at the fundamental aspects of the job requires significant time and energy. Nabeel Hyatt admitted they don't consider themselves proficient yet and are still focused on mastering their primary responsibilities before expanding into additional roles.
Q43: Can the framework for categorizing AI startups be explained? What criteria are used to differentiate between categories?
Nabeel Hyatt presented a framework for categorizing AI startups, which was originally developed during the mobile revolution and has been reapplied to AI. The three categories are adaptation, evolution, and revolution. They clarified that this is an old lens being reapplied rather than a new framework, as they believe we are no longer in the age of frameworks.
Q44: Could the three categories of AI startups be elaborated on using the mobile analogy? How does this analogy help in understanding the landscape?
Nabeel Hyatt explained the three categories:
- Adaptation: This involves taking existing products and creating AI versions. In the mobile era, this was exemplified by the New York Times creating a mobile version of their website. In 2023, adaptation in AI included launches like Adobe Firefly and Spotify DJ, where established companies introduced AI products.;
- Evolution: This category involves new workflows and slightly changed behaviors. In the mobile era, Instagram exemplified this by introducing a new behavior compared to previous photo-sharing platforms. In AI, this can include both startups and incumbents creating evolved products with new behaviors, such as AI meeting note software or Replit agents.;
- Revolution: This category represents entirely new platforms that only exist because of the new technology. In the mobile era, Uber was an example. In AI, these are platforms that fundamentally change how things are done and could not exist without AI technology.;
Q45: Which category of AI startups is currently most prevalent, and which is least common? What factors contribute to these trends?
Nabeel Hyatt observed that the market is currently dominated by adaptation and evolution categories. Many startups are trying to create arbitrage opportunities to get through incubators and raise seed rounds. There are numerous evolved products that are not yet good enough, or adapted products with a superficial AI layer.
Q46: What type of AI startups are found most interesting as an investor? What characteristics make these startups stand out?
Nabeel Hyatt stated that their largest exits and most satisfying work at Spark Capital have been in the revolution and sometimes the evolution categories. They have no desire to invest in adaptation-type startups. Instead, they lean towards more disruptive, higher-risk opportunities, acknowledging that while not all will succeed, the journey is worthwhile.
Q47: Can the investment strategy regarding foundation models and application layers in AI be explained? What considerations are made in this strategy?
Nabeel Hyatt clarified that they don't consider their strategy as hedging. They believe both foundation models and application layers could be successful. They mentioned being an early investor in Anthropic and feeling positive about the investment's future prospects.
Q48: Can the bull case for Anthropic be described? What factors contribute to its potential success?
Nabeel Hyatt suggested viewing Anthropic, OpenAI, and ChatGPT (competitors in the foundation model space) through the lens of the adaptation, evolution, and revolution framework they had just discussed. They implied that this framework could provide insight into the potential and positioning of these companies in the AI landscape.
Q49: If trying to create the next best model and running out of data, what is needed? What strategies are employed to overcome this challenge?
Understanding how users interact with and want to use a model is crucial for its development. A large user base provides valuable insights into user behavior and preferences. Companies with user interfaces can collect data exhaust, revealing how users navigate and utilize the model. This level of insight is not easily replicable by academic labs working in isolation.
While creating faster algorithms is important, obtaining new data from consumers is equally critical. For instance, OpenAI likely has access to ten times more consumer data than Anthropic, which represents a substantial competitive advantage. Both OpenAI and Anthropic benefit significantly from having user interfaces and user data, enhancing their capabilities.
Companies like DeepSeek are gathering more consumer data and insights than many other entities. The competitive landscape is evolving, and companies must adapt to maintain their edge. Questions arise about whether they have enough users and growth to sustain their operations. Owning the customer interface is essential, as it allows for continuous iteration and improvement based on direct feedback.
The next phase of development for companies like Anthropic and OpenAI will be driven by insights gained from customer interactions. Model quality alone is not sufficient; the ability to innovate, execute quickly, and maintain a direct relationship with customers is equally important. This approach contrasts with academic labs focused solely on computational resources, which may not yield long-term benefits.
The notion that massive capital investment is the sole barrier to entry for creating these models has never been fully accepted. Investments in companies like Anthropic were made with the understanding that success does not solely depend on capital. Anthropic's success hinges on its ability to execute rapidly and with a keen sense of product taste. Listening to customers and delivering what they want is a core strategy for success in both the API business and consumer markets.Being at the forefront of innovation necessitates a vertical approach, ensuring a strong connection between the model being developed and the consumer's needs. Data exhaust, which encompasses consumer insights, is more critical than the models themselves. An example of this can be seen in companies that not only provide a user-friendly interface but also capture every edit made by users to refine their offerings.
The current landscape reflects a shift from the wisdom of crowds to the wisdom of VC investors. The goal is not to aggregate average outputs but to harness insights from top performers across various fields. Running a next-generation product with AI deeply integrated allows for the collection of valuable user feedback, which in turn informs product development and model refinement.
The promise of AI is to serve as an intelligent assistant, enhancing human capabilities. Conversations with industry leaders highlight the potential of hyper-verticalized markets that may have previously seemed uninteresting. The replacement of traditional labor roles can lead to the emergence of multi-billion dollar markets.
Q50: How should entrepreneurs approach innovation and long-term planning in the AI industry? What strategies are recommended for success?
Interviewee advises entrepreneurs to assume they will need second, third, and fourth acts in their businesses to keep innovating. This is crucial to avoid being overtaken by competitors who will also build AI-powered solutions in specific vertical markets. Nabeel Hyatt emphasizes the importance of tackling hard problems that are not easily solved by today's AI. They suggest picking a job or decision that is not perfectly solved by current AI and would be worth pursuing for the next decade. This approach allows for continuous innovation and progress, even if initial results are imperfect. Nabeel Hyatt contrasts this with short-term thinking, where founders might aim for quick solutions that can be completed within a 3-month incubation period, which could lead to being overtaken by numerous competitors doing the same thing.
Q51: What advice does Nabeel Hyatt give about analyzing investment decisions and founder selection? What insights are offered for making informed choices?
Nabeel Hyatt suggests focusing on successes rather than losses when analyzing investment decisions. They recommend studying successful investments by examining factors such as how they found the founder, what signals were present, what lessons can be learned, what types of founders connect well with the investor, what the market dynamics were at the time, and what the product was like. This approach emphasizes learning from positive outcomes rather than dwelling on losses. Nabeel Hyatt also notes that if a poor decision was made due to being in a bad state of mind, it's important to recognize that and avoid making decisions in similar circumstances in the future.
Q52: What is Nabeel Hyatt's perspective on the U.S. economy and investment landscape? How do these views influence investment strategies?
Nabeel Hyatt expresses strong optimism about the long-term prospects of the United States. They believe that the confidence in U.S. public markets is unparalleled, although they personally are not investing in U.S. public markets at present. Nabeel Hyatt takes a long-term view, typically considering a 7-10 year horizon for investments. They note that a significant number of people want to move their money to the U.S. and invest in various sectors such as data centers and real estate due to the state of the economy. Nabeel Hyatt maintains that they would be optimistic about the U.S. regardless of the outcome of any particular election, indicating a belief in the country's fundamental strengths beyond short-term political changes.
Q53: How does Nabeel Hyatt view Europe's investment landscape compared to the U.S.? What are the key differences and similarities?
While Nabeel Hyatt acknowledges that there are exceptions to every rule and they would invest in the right founder and environment anywhere in the world, they express a preference for the U.S., particularly San Francisco, for startup founders. Nabeel Hyatt cites challenges in Europe such as difficulties in recruiting talent and raising money. They argue that given the inherent challenges of starting a company - where the default state is failure - and considering the current age of AI, founders should strongly consider basing themselves in San Francisco to mitigate risks and maximize opportunities. This perspective suggests that Nabeel Hyatt sees significant advantages in the U.S. startup ecosystem, especially in the AI sector, compared to Europe.
Q54: Can somebody succeed in London or Berlin as a founder? Why would a founder choose these locations over San Francisco? What advantages do these cities offer?
Of course, founders can succeed in London or Berlin. However, the real question is why a founder would make that choice. The problem is that more of the people who are truly all-in, not just saying they are, but actually willing to sacrifice everything to put themselves in the best position to win, are going to want to be in San Francisco. They want to be at the dinner where they're learning about AI and be able to recruit the best people. All those people are in San Francisco right now, so it's a compelling reason to be there.
Q55: What are the challenges of talent acquisition in San Francisco? How are these challenges being addressed by companies?
Talent acquisition in San Francisco is extremely difficult. The job market is very dynamic, with employees frequently changing jobs. This promiscuity incentivizes a system where companies have to keep innovating and maintain speed, or they need to have synthetic growth. There's a downside to this environment, but it also pushes companies to be smarter and separate themselves from the competition.
Q56: How is the conversation with founders approached about what they need to do to raise their next funding round? What guidance is provided to prepare them for success?
I don't particularly like that conversation, although I understand its necessity. It feels like we're just packaging founders and passing them along. Instead, I usually try to start by asking them questions about how they think about the future, attempting to separate their vision from how a VC thinks about the future. Ultimately, VCs are listeners more than tellers. The future is invented by founders, so the question becomes: What can you surprise an investor with in 2026 that they weren't asking about?
Q57: How are founders helped to think beyond meeting investor expectations? What strategies are used to encourage long-term vision and innovation?
If everyone expects a company to reach $8-10M ARR, then investors probably won't invest if they merely achieve that because they want to invest in companies that exceed expectations. I encourage founders to think about what would really surprise them about their business. What would shock them or make them feel amazing if they woke up a year from now? We then work on packaging that vision. It's about storytelling more than just numbers. People default to numbers when they have no other story to tell. I ask founders to tell the story about what they want to be able to tell the world in 18 months about their product and company, and then we figure out if that's viable or if they're sandbagging.
Q58: What happens to enterprise companies that have raised seed and Series A rounds over the last 3-5 years and are now at $8-20M in ARR but not growing as fast as AI companies? What strategies are employed to address this situation?
This is a challenging situation without a clear answer. Some founders in this position are still growing and doubling their revenue, but that's not enough for VCs who are now used to AI company growth rates. It's concerning because these companies aren't stagnating, they're still growing, but they may struggle to attract further investment in the current climate that favors exponential AI-driven growth.
Q59: What has changed in Nabeel Hyatt's mind over the last 12 months? What new insights or perspectives have been gained?
Nabeel Hyatt doesn't think we should evaluate any company by the models that are underneath it, even model companies. This shift in thinking has made many traditional business school approaches obsolete. He's thrilled about this change as he can't work in Excel spreadsheets effectively.
Q60: How was parenting approached differently from one's own upbringing? What lessons were applied to raising children?
Nabeel Hyatt didn't do much differently because I think my parents, despite not understanding me at all, were incredibly open to me walking my own path. My mother was a first-generation immigrant who might have wanted me to be a doctor or lawyer, but unlike many immigrant families, she never pressured me. She could tell I was going to walk a weird path, and she just wanted me to find my place. So, I'm more trying to mimic my parents' approach than do the opposite.
Q61: Is a hands-off approach taken as a parent, allowing children to do what they want? What parenting style is preferred?
Nabeel Hyatt is not hands-off as a parent, but rather hands-on. He shared a personal anecdote about his own experience, where his parents were supportive of their unconventional choices. After his sophomore year in college as a computer science major, he considered leaving university to start a company. He ended up going to art school, and their parents were completely supportive.
Q62: Does being wealthy make one a better investor? What impact does financial status have on investment decisions and strategies?
Nabeel Hyatt has a strong thesis that wealth does make one a better investor. This is because wealthy investors no longer worry about downside, their next fund, or protection. They can focus on seeing the world differently and taking creative risks. He emphasized that having a "nothing to lose" mentality allows an investor to sit on the front end of creative risk, which is crucial in venture capital. This approach contrasts with a protectionist mindset focused on job security and getting to the next fund, which can lead to mistakes. He values the ability to take extra risks, as that's what the venture capital business is about.
Q63: What advice would be given to young Harvard Business School-style investors who have been used to the last 5 years, to prepare them for the next generation? What skills and perspectives are essential for future success?
Nabeel Hyatt highlighted the challenge with this cohort, noting their rigid mindsets due to their structured educational and professional backgrounds (top schools, investment banking, consulting, etc.). He drew a comparison between musicians and athletes, stating that venture capital is more akin to a creative exercise than a fixed game like sports. Markets, founders, and products are constantly changing in venture capital. The key advice is to help these young investors understand how to navigate uncertainty with confidence and without terror.
Q64: Why do musicians often struggle with their second album, while athletes typically improve in their second year as professionals? What factors contribute to these differing trajectories?
Nabeel Hyatt explained that the "sophomore album problem" for musicians stems from the core creative nature of their work. Unlike athletes who operate within a fixed game with known parameters, musicians face a more open-ended creative challenge. In music, there's no predetermined "right answer" or clear path to improvement. Athletes, on the other hand, can refine their skills within the established rules and structures of their sport. This difference highlights why venture capital is more similar to the creative challenges faced by musicians than the structured improvement path of athletes. The venture market is constantly changing, making it more of a creative exercise than a mathematical one.
Q65: How did making money from selling a company change one's mindset? What new perspectives or priorities emerged from this experience?
Nabeel Hyatt stated that making money didn't significantly change their mindset or how they execute. They approach their work with the same attitude they had during the early stages of entrepreneurship, even when facing financial challenges. He emphasized that they enjoy playing the game for the joy of it, regardless of the circumstances. While acknowledging the importance of financial success in venture capital for the benefit of limited partners and founders, Nabeel maintains focus on enjoying the work itself.
Q66: How is success measured in venture capital, especially early in one's career? What benchmarks and criteria are used to assess achievement?
Early in their venture capital career, Nabeel Hyatt initially tried to measure everything to gauge their performance. However, they credit Bijan, who recruited them to Spark, for providing a different perspective on success. Instead of focusing solely on metrics, Bijan encouraged him to consider two simple questions: Did you enjoy the work you did today? Do you want to come back and do it tomorrow? This approach emphasizes the importance of finding fulfillment in the day-to-day work rather than obsessing over quantitative measures of success. Nabeel learned to prioritize enjoying the process and maintaining enthusiasm for the job, suggesting that passion and engagement are key indicators of success in venture capital, especially in the early stages of one's career.
Q67: How should the venture capital market be restructured to better serve founders and foster innovation, considering the evolving structure of venture capital investments, particularly the trend towards common shares and the traditional passive investor model? What changes are necessary to align interests and promote growth?
The current venture capital market structure is not optimally aligned with fostering innovation or adequately serving founders. A significant restructuring is necessary to address these shortcomings and create a more conducive environment for exceptional companies to thrive.
In an ideal scenario, 10 to 15 years from now, the venture capital industry would recognize that evaluating high-innovation companies cannot be reduced to a simple checklist. The nature of investing in exceptional companies requires a more nuanced and flexible approach that goes beyond traditional metrics and evaluation methods.
The venture capital market should evolve to better identify and support truly innovative and exceptional companies. This may involve developing new evaluation methodologies that can capture the unique potential of groundbreaking ideas and technologies, rather than relying on standardized criteria that may overlook or undervalue unconventional approaches.
A restructured venture capital market would prioritize the needs and vision of founders, providing them with the resources, guidance, and flexibility necessary to pursue innovative ideas. This could involve more founder-friendly terms, longer-term investment horizons, and a greater emphasis on partnership between investors and entrepreneurs.
The venture capital industry has been undergoing significant changes in recent years, with founders increasingly expressing a preference for alternative investment structures. One notable trend is the growing desire for common shares instead of preferred shares. Historically, venture capital has been a unique industry since its inception. The traditional model involved investors taking a minority stake in a business while maintaining a passive role, typically limited to board representation. This approach was a departure from conventional investment strategies that often sought majority ownership and active control. Venture capitalists have traditionally operated in a "lean back" position, offering guidance and support without direct operational involvement.
The current evolution in venture capital structures raises important questions about the future of the industry. It's crucial to consider what the optimal model should look like, taking into account the interests of both investors and founders. This conversation extends beyond simply discussing the merits of common shares versus preferred shares. It involves a comprehensive examination of the entire venture capital ecosystem, including governance structures, investor rights, and the balance of power between founders and investors.
While there isn't a definitive answer to what the ideal venture capital model should look like, engaging in this discussion is productive. By exploring various perspectives and potential structures, the industry can collectively work towards refining and improving the venture capital model. This process may involve gradual changes and experimentation with different approaches, allowing the industry to adapt to the evolving needs of both entrepreneurs and investors.
Investment terms and structures have undergone significant changes over time. These alterations include variations in preferred or common stock offerings, modifications to term sheets, and adjustments to liquidation preferences. The investment landscape has become more dynamic, requiring adaptability from both investors and founders.
Q68: What questions have not been asked that should have been, and how can the venture capital market ensure alignment among stakeholders while avoiding purely transactional relationships? What strategies are recommended for fostering collaboration and mutual benefit?
Despite these changes, the primary focus remains on enabling founders to build successful companies. It is crucial to ensure that all stakeholders, including those brought into the company's orbit, are committed to the same cause and share a common vision. This approach fosters a sense of unity and purpose within the organization.
Treating investments and relationships purely transactionally is counterproductive to the goal of building strong, sustainable businesses. Instead, the emphasis should be on cultivating long-term partnerships and aligning interests between investors and founders. This collaborative approach helps create an environment conducive to growth and innovation.
The ultimate objective is to support founders in their journey to create impactful companies. By maintaining flexibility in investment terms while prioritizing shared commitment and avoiding purely transactional relationships, investors can contribute more effectively to the success of the ventures they support. This approach not only benefits the individual companies but also contributes to the overall health and dynamism of the startup ecosystem.
