Fred Destin

Don’t believe the hype.  Yes, it’s a nice environment to be starting the winners of tomorrow and seed funding has not dried up.  And yes, Wellington and friends feel Spotify is the [Google][Apple] of media and pay (supposedly) €200m pre for the privilege of working with the excellent Messieurs Ek and Lorentzon.

But do not let these facts distract you, for most companies are facing a period of extended drought.

The focus should not only be on current activity but also on forward looking indicators such as this one: 75% of funds surveyed by Ernst and Young in Q1 indicate they are increasing reserves.

A number of effects are at work here:

• LPs closed for new business: Many funds are either failing to raise or are deciding to postpone their fundraising.  Hence they have to live for longer with the cash at hand.  That means reduced investment pace and a generally defensive stance.
• Companies in need: Companies are needing more cash.  Even late stage “safe” businesses suddenly revert to spending hundreds of thousands a month as they grapple with a tough economy and expansion plans gone wrong.  Exit are few and far between and the alternative sources of finance have dried up (venture debt, public markets etc).
• Optimistic funds chastened: Most funds were under-reserved for this crisis.  In other words, the ratio of reserves held back versus capital invested was too low.  Now, as you decide to hold back say $2 per $1 invested, all of a sudden cash planning shows a massive gap.  The result is ruthless portfolio triage and weakened syndicates.
• Uncertain future: most of all, lack of visibility on when this crisis ends and when liquidity returns block decision making and risk taking
• Existential crisis:  the industry must shrink, the GP’s often need to reinvent what is they do, the legitimacy of the sector as a whole is in question.  Behind the short-term angst are some good questions about the abundance of fairly undifferentiated venture capital out there chasing fairly undifferentiated deals in shrinking niches.  But more on that some other day.

Net-net, the result is a two speed market where

• Atlas / Accel / Balderton/ Index / Wellington / Greylock / fill the blank are fighting hard for the “must-do” deals (wonga, just-eat, spotify etc)
• 75% of companies receive a firm but polite “no thanks, unless this is a recap” and are having to rely on their existing syndicates

Welcome to “pay-to-play” country where weakened investors who cannot follow their cash get washed out and often entrepreneurs along with them.  I have an aboslute sense of deja-vu from Q2-Q3 2003 here that is hard to shake.  Sure, this may the coming of age of VC-less bootstrapping and low capital intensity, no question.  But this exicting view of the world is oflittle solace to all the existing businesses out there who are VC backed and will have to rely on their existing investors for survival. 

We seem to be turning a corner and the worst may well be behind us, with some new fund initiatives such as Birch/Hoberman’s ProFounders or the Boyz at Atomico.  But this will not solve the funding crunch fast.  For most companies out there in the “grey zone” (worthy but not obviously hot), it’s tough and it’s going to remain that way.