9 West 57th Street will be as important to the next generation of company-building as Letterman Drive was to the last.
Long Lake and Thrive Holdings are products of an explicit acknowledgement that the successful diffusion of AI throughout the economy requires a totally new approach to capital formation foreign to venture capitalists. They reject the idea that transforming the multi-trillion-dollar legacy services economy will happen, inevitably, if only San Francisco-based engineering teams sell enough convertible preferred equity to finance the production and distribution of prepackaged workflow automation software to arm’s-length customers. Success demands something entirely different: principal investment, a deeply embedded team, and operating control.
The staggering amount of paper issued by leading AI companies to finance the superintelligence race is also an acknowledgement that the venture capital model has slammed into its limits, not because it failed by any means, but because it naturally cannot and should not scale. The aggregate risk in the technology economy for which ultra-expensive risk capital is appropriate pales in comparison to the sheer scale of economic activity that must be financed differently.
Private technology companies will deliver outcomes that are bigger and require more capital than ever before: AI is a centralizing force that rewards and reinforces scale, and the companies built around it are extraordinarily capital-intensive. But it is obvious that the venture capital product alone is woefully insufficient to finance the next generation of technology companies, and that cementing American technological supremacy requires an entirely new, deeper, and more thoughtful capital markets apparatus.
It is remarkable to contrast the overwhelming evidence that “seed investing” and “growth equity” are totally insufficient with the escalating race between megafunds to raise ever-larger traditional venture capital vehicles. With a handful of exceptions, these firms have been locked in a totalizing struggle for venture supremacy that has collapsed the differences between them – and they’ve overlooked or actively dismissed the question of whether their chosen game is even worth winning.
As the scope of technology companies’ ambition grows well beyond what equity dollars alone can finance, great technology companies – and the firms that support them – will necessarily embrace something they have largely rejected for decades: credit, originated at unimaginable scale that will make the venture capital industry as we know it look quaint by comparison.
Large swaths of the technology ecosystem resent this reality or even reject it, waxing poetic about the importance of maintaining a “cottage industry.” The coming credit tidal wave means that megafunds will be bigger than ever before; there is a reason that annual credit issuance in this country dwarfs equity issuance by an order of magnitude. These people are Silicon Valley’s zanryū nipponhei, fighting a battle that has already been lost, steadfast in their worldview but fundamentally making a normative argument rather than a positive one: we have crossed the chasm on scale, and the industry will very obviously keep growing. Those uncomfortable with the reality that the amount of capital in the technology economy will only grow bigger can simply opt to do something else. The notion that one must “play the game on the field” even when he doesn’t like the rules is a dangerous lie.
A different – though overlapping – set of people rejects this reality because they simply don’t understand or don’t like credit. They dress their criticisms up in sophisticated language around “cost of capital” (as if equity were somehow free) or “adverse selection” (as if the best companies in every industry didn’t rely on credit).
Until the frenzy around compute financing, Silicon Valley largely treated credit as a monolith, synonymous with low-value venture debt: at best an afterthought, at worst something to actively avoid. Those attitudes were the product of a deeply ingrained equity culture and a remarkable, industry-wide dearth of financial sophistication, downstream of prior tech waves and a macroeconomic backdrop that rewarded product, design, and engineering excellence and often ignored or punished financial acumen. But those attitudes are now entirely anachronistic.
Indeed, the sheer capital intensity of the AI boom made credit impossible to ignore, and Silicon Valley quickly accepted that fully achieving its frontier AI ambitions required embracing credit at near-trillion-dollar scale – so much so that even at the formation stage, seed investors demand answers from companies about their strategy to finance compute. We are very close to a watershed moment at which the entire industry accepts that thoughtful balance sheet construction is critical to successful company-building.
That credit will drive the next order-of-magnitude growth in Silicon Valley is inevitable. Venture capital simply cannot scale enough. The surface area of investable opportunities for technology companies is inherently narrow in a world where expensive equity is the only available instrument and expands dramatically when these companies’ cost of capital falls; what is value-destructive and thus uninvestable when financed with equity becomes highly accretive when financed with cheap credit. Just as importantly, confidently scaling the operating ambition of a business is possible only when capital availability depends more on underlying asset fundamentals than on fickle market sentiment or the distortions of a broken market structure. And only with a properly constructed balance sheet can a business take liquidity into its own hands and fulfill the tacit promise it made to its shareholders and early employees, a promise that, when broken, threatens the entire technology economy.
Expanding technology-focused credit markets has nothing to do with shuffling around the pieces of the pie and everything to do with building much larger, more valuable, more liquid companies than ever before – in a way that equity markets cannot and will not support.
Every pre-AI software business has learned what happens – in brutal fashion – when scaled, asset-matched credit for technology companies does not exist. It is the responsibility of scaled capital allocators in Silicon Valley to ensure the next generation of technology companies doesn’t suffer the same fate.
@Alex_Danco foretold the credit wave nearly seven years ago when he wrote Debt is Coming. Remarkably little debt ever came, however, at least until the AI wave demanded it. Today’s venture trade still involves the same five firms hawking the same undifferentiated capital product into the same companies; tomorrow’s will involve packaging the hard assets and structured cash flows that now sit within the technology economy, in increasingly novel and creative ways, and soaking up the trillions of dollars of allocator demand for predictable yield.
9 West 57th Street will be as important to the next generation of company-building as Letterman Drive was to the last – technology financiers will trade their hoodies and burnt coffee at the South Park Blue Bottle for suits and pasta à la presse at The Grill.
It is tempting to conclude that credit at this scale is impossible, that the vast majority of technology companies are unprofitable and thus not worthy of credit. That conclusion is correct if one narrowly believes “credit” is synonymous with “fully recourse corporate obligation with a fixed maturity.” The combination of recourse and fixed repayment schedule can impose a death sentence on a technology business incurring losses in service of investing in the future. But that is far too simplistic and narrow a view, totally at odds with the abundance of underwritable assets that exists within today’s technology businesses – if only one shows an ounce of creativity.
One should focus on what can be, unburdened by what has been.
Technology companies are not indivisible. They can be speculative at the aggregate, corporate level but contain hard assets and other investments whose returns are highly structured, range-bounded, and predictable in nature – assets that are independently financeable. Next-generation aerospace, defense, and industrials companies own financeable collateral with clear depreciation schedules and have milestone-based contracts with the most creditworthy counterparty in the world. The AI transformation companies acquire legacy businesses that predictably generate profits. “Asset-light” software, internet, and DTC companies originate customer cohorts with predictable repayment curves – not dissimilar from specialty finance businesses that originate loans with predictable amortization schedules. There are assets as far as the eye can see, many of which can be financed with low-cost, duration-matched credit based only on their fundamental value.
Debt won’t simply come. Someone must bring it. Some of these assets are legible to traditional lenders. But so many are not – and financing them will be done best by technology-native megafunds or new entrants that balance traditional credit heuristics with the realities of the modern technology company. CVF has already built a $6B business around this opportunity.
This makes the race among nearly every venture major to raise $10B+ and soon $20B+ venture capital funds so perplexing, a total distraction from the game that anyone truly focused on scale should play: exploring the frontiers of novel credit. It is the only game that affords the opportunity for new entrants and for existing megafunds to grow by another order of magnitude. AUM supremacy is a worthy goal even if ventureAUM supremacy is not – the explosion of the venture capital ecosystem on the back of multiple technology waves, declining interest rates, and massive government spending post-GFC enabled the growth from $5B to $50B but will not enable the growth from $50B to $500B. Credit is what both companies and allocators demand. Firms should focus on actually delivering it.
A transition from reliance on venture capital alone towards scaled credit is neither unprecedented nor one to fear. The firms that pioneered and popularized the leveraged buyout, an equity strategy just like traditional venture, ultimately became multi-strategy alternative asset managers dominated by credit. KKR, perhaps the single most famous buyout firm, now manages nearly $300B of credit assets, substantially more than it does in its equities business. And Apollo, also known in its early days for its buyout investments, has turned into a private credit behemoth that happens to do some private equity. The conflict-of-interest, reputational, regulatory, governance, capital markets, and operational challenges of multi-strategy transition are inevitable but surmountable. If one believes that technology companies need vastly more capital – and wants to architect a firm around that premise – it is impossible to ignore credit.
Building any generational investment firm – rather than a boutique partnership that simply manages a small collection of subscale funds – is an exercise in identifying and capitalizing on secular waves in capital formation. What Thrive has built over the last fifteen years is a testament to this: the loyal, long-term shareholder of record for the best technology businesses in the world riding the wave of companies staying private longer.
The direction of travel in the private capital ecosystem for technology companies is overwhelmingly away from traditional venture alone and towards low-cost credit at scale. Great fortunes in investment management will be made by following it.
Thanks to @aashaysanghvi_ @lucasbagnocvaz and @_susanarojas for their feedback on this piece.
