What VCs actually do in a down market

So, last time I said that seed deals on really disruptive risky technology that can be game changing when the market recovers should go for early stage VCs ... Well, some are rubbing their hands together--either in excitement over predatory deals they can do to struggling entrepreneurs (or at cramming down their hated VC rivals), or in apprehension over how they will raise the next fund. Sadly, most have their hands in their pockets, or are sitting on them pretty firmly, reluctant to put them into their pockets for fear of having to take cash out.

We are seeing financings fall apart in literally the 11½ hour, when all the existing investors have transferred money, and the new lead lobs in a last minute call to say sorry our partners have decided we aren’t doing these type of deals anymore. This begs the question, "so what type of deals are you doing then?" Simple, they are doing C-round deals at A round prices--VCs trying to do later stage deals--I think that’s an OK strategy but there are already a lot of late stage firms out there who are better at that than early stage VCs are, so suddenly you end up with a competitive environment (albeit a weak one) and your bargain deals aren’t that much of a bargain anymore.

VCs are largely in decision paralysis, they triaged their portfolios, forgeting the companies that are likely to fail and reserving as much cash as they can for those they think can still win even in this market. If you are portfolio CEO don’t worry most of them went through this exercise back in Sept (but they do it monthly or at least quarterly too). Now they are wondering just how bad it will be--they certainly aren’t excited to fund chip deals, or medical devices. Anything that is going to need $50M+ and then mezzanine financing is out for now. (Personally I think this is actually a good place to invest if it’s the right deal). Anything consumer is largely out--and thank God no more social networking or internet dating deals (at least for a while)--sorry Web 2.0 guys but you had a great run. Cleantech is still OK, but no panacea--there is a lot of hype that still has to clear the system before anyone will make real money in that area, and the lack of later stage financing will kill many of those deals.

Syndication is back in, even in A rounds many VCs are wanting to get two and even three firms around the table so there is enough dry powder to carry the company through. The behaviors of VCs is often driven by their Limited Partners' behavior, and many LPs are telling their General Partners “don’t put us in a position to say no to you.” In other words don’t call any more capital for a while until we can sort out this mess--so no deals. Other LPs are saying, "why is your fund so big when you are not doing any deals--give us our money back." Many VCs are increasing their reserves for existing portfolio companies both to extend their ability to support the companies and to keep the money away from their LPs. The worst case scenario is the VC who is almost at the end of their investment period--they need to reserve more cash but have little chance of raising a new fund until they get some exits, and the IPO window is firmly closed.

The LP perspective on this is, "don’t complain to me about the IPO window, where are my returns?" This is not an unfair ask, actually, as VCs we always expect our CEOs to take personal responsibility for everything, so why shouldn’t we hold ourselves accountable to the same standard? Also, Venture is supposed to be key to any portfolio in order to “flatten out the beta.” Well there sure is a lot of beta to flatten right now ;-)