I hope you all made the most of the quarantined Easter weekend and are keeping healthy.

In my last two notes (here and here), I wrote about government funding solutions for startups and scaleups during the Covid-19 crisis. This week I am going to change tack a bit to look at private sector funding and the debate emerging around what I’ll call the “dry powder question”.

Quick Update on Save Our Startups

But first, a check-in on the Save Our Startups campaign, which I wrote about last week. We’ve been thrilled that over 5,000 people have already signed the petition, and it has gotten widespread media coverage. More importanty, it appears the Government is listening: yesterday’s Telegraph reported that Treasury is getting ready to announce a startup rescue package along the lines of what the campaign has called for, and I am hearing similar indications from my contacts in Whitehall. So hopefully there will be good news to share shortly.

The Dry Powder Question

One of the reasons why government support for startups and scaleups is so important, as I discussed in my last two notes, is that CBILS—the small business lending scheme launched by the Government at the beginning of the crisis—doesn’t work for high-growth loss-making businesses. As it turns out, there are some questions around whether CBILS is even working for the businesses for which it was intended, but that is a separate point. The key issue is that there is not yet a government support programme suitable for the country’s most innovative and high-potential young companies.

But we wouldn’t even be talking about government support if it looked like private sector investors could solve the cash problem that so many startups and scaleups will now face. And when I say private sector investors, what I really mean is venture capital firms, or VCs. Much as I believe that investors of all shapes and sizes should be able to invest in this asset class—and thanks to Seedrs and others, the capital base has diversified substantially over the last decade—by far the majority of capital that goes into startups and scaleups still comes from VCs. So the private sector’s ability to plug cash shortfalls is primarily a question of what the VCs can, and will, do.

Enter the dry powder question. In broad terms, dry powder is the amount that VCs have raised but that has not yet been invested. And there is a lot of it out there: in the UK and Europe alone, there are billions (or, depending on how broadly one defines VC, tens of billions) of pounds of dry powder that is theoretically available to support startups and scaleups during this period. What’s more, pretty much every VC general partner (general partners, or GPs, are the people who manage VC firms and the funds they raise) is saying publicly that they are fully open for business and looking to invest that dry power. There are even lists circulating that purport to show all the VCs who are investing during this period.

So problem solved, right? The cash is there to fund these businesses, and the VCs say they want to fund them. Valuations may be pushed down and terms like preference structures may get more aggressive—which is all just a part of shifting market dynamics—but there is no reason that companies should struggle to raise the cash they need to get through this period. Simple.

Well, not quite. The existence of dry powder on paper and its availability for deployment aren’t always the same thing, and the best laid plans of GPs can easily go astray. This is due to a combination of two things.

One is simply bandwidth. VCs tend to run lean operations even in boom times, and they rarely have much capacity to spare in conducting the relatively labour-intensive undertaking of investing in private companies. So now, with huge amounts of time being taken up supporting portfolio companies, and lots of their remaining time being taken up by external pressures that this crisis has created (including things like providing childcare), many GPs will face a real operational struggle in making new investments. Elizabeth Yin, who runs the well-respected San Francisco seed-stage VC Hustle Fund, wrote an excellent thread on the nuances around this issue a few weeks ago. I expect many other VCs find themselves in a similar position to Elizabeth.

The other, probably more significant, issue is in the notion of what dry powder really is. I said earlier that it’s money raised by VCs that has not yet been deployed, but “raised” is a nuanced word. In reality, most dry powder represents commitments by the fund’s investors (known as its limited partners, or LPs), meaning that the GP still needs to call on the cash from the LPs, and the LPs still need to pay it over. Hence we get into conversations like the one below from LinkedIn (which you can see in full here) between two people who know this ecosystem very well:

What are the implications of Michael Chaffe’s observation? Is it likely that LPs will simply stop responding to capital calls during this period, letting the dry powder go up in smoke? Not exactly: the penalties on an LP for missing a capital call are severe—the LP basically forfeits its whole stake in the fund—so except in the case of new funds, where there is no stake yet to lose, I doubt we will see a lot of LPs simply saying “no” when the GP comes knocking.

But that doesn’t mean LPs are powerless. The mere prospect of a refused capital call will make many GPs nervous. More than that, GPs will be thinking about their future funds. If they do something today that upsets their LPs, then when it comes time to go back to those folks for Fund 2 (or 3 or 9), they may find a lot of doors shut in their faces.

And that is the key to the dry powder question. If LPs don’t want the funds in which they have invested to be deploying capital right now, then they are able to put a lot of pressure on the GPs not to deploy capital. Are they actually doing so? Yes, although the extent is hard to tell: anecdotally there are stories of LPs exercising their power one way or the other during this time, but as we all know, the plural of “anecdote” is not “data”.

More concerning than the stories is the simple reality of LPs’ positions: most are institutions who invest across multiple asset classes, and when they make a commitment to a VC fund, they often invest the cash in a different, liquid asset—such as listed stocks and shares—until it is called by the VC. With valuations of so many major liquid assets having taken a big hit over the past two months—but with expectations of a strong rebound after the crisis is over—many LPs will be loathe to sell their holdings at the moment. There will of course be plenty of exceptions, but it is inevitable that what is happening in the global markets will mean a significant number of LPs will want to reduce the amount of cash they need to hand over to GPs right now.

And that is what leads to a private sector investment crunch. The dry powder is not exactly going up in smoke, but much of it will be locked away in the magazine until this crisis is over.

Resources and Musings

Here are a few resources and goings-on I’ve found interesting over the past couple of weeks:

  • From Augmentum Fintech plc, the listed fintech VC (and an investor in Seedrs), comes the brilliant idea of Teen VC, a digital education platform for teenagers to learn about VC and entrepreneurship. This can be a great resource for those of you looking for homeschooling ideas for your teenagers, but it also has a lot of content that people of any age may find useful in learning about the VC landscape.
  • From the Institute of Directors comes a thorough and informative support hub for businesses struggling during this time. There are a number of these sorts of hubs out there, but the IoD’s is among the best I’ve seen.
  • And then from The Dots, the professional network for creatives run by the great Pip Jamieson, comes a set of resources that may be particularly useful for freelances and independents at this time.

Thanks very much to Jimmy McLoughlin (whose Navigating the coronavirus for business newsletter I mentioned a few weeks ago) for highlighting the last two of those.

And finally, a few tweets I thought worth sharing:

  • Larry Kim of Mobile Monkey provides some encouragement by noting a few of the businesses that were founded during the last downturn. He built on his original tweet with this little graphic:
  • Paul Graham, the YC founder and essayist, also reflects on starting a business during difficult times, tweeting: “Investors: Any startup that gets started during the next few months is disproportionately likely to succeed. Success depends most of all on determination, and imagine how determined you have to be to start a startup in the middle of a global pandemic.” Having begun work on Seedrs during the last crisis—which was not nearly as intense as this one, but nonetheless required a heck of a lot of determination—Paul’s view resonates with me.
  • A different sort of perspective comes from a contributor to the popular ZeroHedge blog who tweets: “AirBnB is about to crash the US housing market. Thousands of super-hosts who bought 10, 20, 30 properties with mortgages and are heavily levered…are all about to default. Without travel there is no rental income to pay these mortgages. In 2-3 months – 2008 all over again. Boom.” I highly doubt the data supports the enormity of this statement, but the idea that a slowdown for Airbnb—a business that was selling politically-themed cereal at the time of the last housing crisis—would be sufficient to cause meaningful challenges to the U.S. (and potentially global) housing market does show how a tiny company run by determined entrepreneurs can turn into a significant player in the global economy.
  • Finally, Simon Hoare, the Conservative MP for North Dorset, tweeted the following in response to the Prime Minister’s broadcast from Chequers after he was discharged from hospital: “I have no particular insight on this topic BUT my hunch is that that wonderful, heartfelt address by the PM could (should) presage a recalibration of immigration policy- one where worth is more important than income bracket. It’s what being a liberal One Nation Tory is all about.” Whether one thinks that is likely to happen probably depends on one’s politics and views on Boris Johnson, but it is at least an encouraging thought. For many of us, the greatest practical disappointment of Brexit has been the prospect of losing the talented, ambitious people from all over Europe who have formed the backbone of the startup and scaleup ecosystem. To some extent that remains unavoidable, but wouldn’t it be nice if the dedication of Kiwi and Portuguese nurses wound up nudging the PM toward favouring a somewhat more open Britain?


That’s it from me for this week. As always please do let me know any feedback or contributions, and I hope you all stay well and safe in the week ahead.