The VCs Are Salty
We're living through the revenge of capital, apparently.
My work
Earlier this year, once it became clear we were in a downturn, the advice to founders was to raise internal rounds, cut costs, reduce burn, and drive to profitability. It’s been months since then and most founders are asking ‘Now what?’. I published an article on my company blog laying out a guide to founders on how to think about fundraising in this current market (link).
The revenge of capital
Capital providers are always looking for people who can provide (the promise of) returns. People who (believe they) can provide returns are always looking for capital providers. The balance of power between these two groups shifts based on the availability of capital in a particular asset class and how good the recent performance of that asset class has been.
The history of venture capital has been a story of the balance of power shifting towards entrepreneurs. This shift is most notable in the board room. In 1985, the Apple board famously fired Steve Jobs. At the time, VCs removing the CEO was completely unremarkable. Since the turn of the millennium, founders of companies like Facebook, Snapchat, and Google, have been able to prevent a scenario where they are removed by the board by creating dual-class stock, which allows them to retain control. Most recently, Sam Bankman Fried was able to build a $32B company without even having a board.
Over 40 years, we went from VCs controlling the board, to the founder controlling the board, to the founder not even having a board.
If the balance of power had been slowly shifting over decades, the pandemic, as it was for so many other things, was an accelerant. The availability of capital and the shift to virtual work meant that all assumptions about how VC worked were tested. If you could invest without physically meeting the founder, what other parts of diligence could you skip? Did you have to visit the geography the company operated in? Did you have to speak to customers? If you could invest in a founder you’ve never met, after minimal diligence, did you even need to be on the board? If you weren’t on the board, did it matter if the company didn’t even have a board?
We ran all these experiments over 2020 and 2021, driven by VCs that had more capital to deploy than they had time to diligence and founders that were savvy enough to take advantage of a moment where capital was practically free and widely available.
We’re now starting to see the results of these experiments. In some cases, unremarkably, in others, spectacularly. Some of these experiments are here to stay - for example, I think Zoom investing flattens the world and creates more opportunities to invest in great companies. Som other experiments, however, are not going to be repeated any time soon.
The balance of power has notably shifted back towards VCs and as entrepreneurs look to raise capital, they’ll experience this in a number of ways. I read two interesting articles that explore this dynamic.
The first article was written by Semil Shah about how last year’s easy money has led to this year’s hard conversations.
As an early-stage startup investor, this year, 2022, has been marked by one thing: Hard Conversations.
Lots of them. Each conversation is different, but depending on the situation, they fall into one a few buckets. The hardest are with founders who are already in your portfolio. As an investor, you’ve already made a commitment to them beyond just investment dollars. Following this are new investments and relationships, as most early-stage investors seek to maintain their pace through both good and rough times. And finally, hard conversations with other investor friends in the ecosystem about what to expect.
I wanted to briefly lay out the high-level messages in these conversations. None of this will be new or revelatory for those in the startup world, but perhaps the way it’s framed here can help some folks who are sorting it all out.
The entire article is worth reading.
The second was written by Charles Hudson. My colleague, hilariously but aptly, summarized it as: the VCs are salty. In the article, he explores the emotional context that underlies many of the hard conversations that are being had today. Capital providers come into these conversations with strong emotions about how feel they were treated over the past couple of years as the balance of power shifted pretty aggressively from providers of capital to providers of (the promise of) returns.
Right now I think we are living through what I call the revenge of capital. I don’t know a better way to describe what I’m hearing in my conversations with GPs and LPs – it’s an abrupt, violent rebalancing back toward the preferences of capital providers up and down the stack. This rebalance isn’t purely rational – it’s being influenced by how people feel about the last few years and how they feel they were treated by people in the ecosystem on the way up to the peak. And how they feel about things during the current decline.
Again, the entire article is worth reading.
Finally, I wrote an article on these same themes. If 2021 was all about an acceleration (of growth, technology adoption, funding, valuations), then 2023 is going to be about a rebalancing. For entrepreneurs, this requires a different mindset, and I described it in my article with this metaphor:
Savvy entrepreneurs understand that in times like these, they must operate like Formula 1 drivers. F1 drivers brake just enough to navigate the curves on the road without losing too much speed and then accelerate immediately out of the turn to overtake rivals. Difficult environments often provide an opportunity for entrepreneurs who know how to navigate them. Legendary F1 driver, Ayton Senna famously said, “You cannot overtake 15 cars in sunny weather… but you can when it’s raining.
All three articles are worth a read, but mine is the best of course :)