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Venture firms held back on investment in 2022 as inflation skyrocketed, the economy stalled and markets tanked. The floodgates may be about to open.
Dry powder — the highly liquid, unallocated capital a venture capital firm has on hand that’s waiting to be invested — has reached record high levels.
Jon Sakoda, founder of early-stage venture firm Decibel Partners, analyzed close to 10 years worth of venture fundraising and investment activity, The Information reported.
He found that venture capital firms are sitting on a $290 billion powder keg, with $162 billion of that designated for new investments.
That dry powder is ready to ignite a new wave of tech startups, Raphael Mukomilow and Pierre Bourdon wrote for Tech Crunch.
However, not everyone is buying the dry powder narrative, including Ben Parr, a journalist-turned-founder and artificial intelligence operator. Parr is the co-founder and president of OctaneAI, an automated messenger bot service that connects directly to Shopify. He wrote the book “Captivology: The Science of Capturing People’s Attention.” Parr was named one of Forbes’ 30 Under 30 in 2012.
“Everyone keeps talking about how VCs have so much ‘Dry Powder’ to invest” Parr tweeted. “It’s all B.S.”
VCs don’t physically have the money, Parr explained in a long Twitter thread. And they don’t have to use it anytime soon.
When a VC raises a fund, they don’t usually have all the money up front, Parr said. Instead, they have commitments from their investors (the limited partners) and they “call” the capital as needed per investment.
“Those LPs though? They’re pretty tapped out,” Parr continued. “Their investments have significantly dropped in value — public markets, private holdings, etc.”
Other assets have become more illiquid, Parr added. If all the venture capitalists called that $300 billion now, limited partners would feel a lot of pain and some wouldn’t be able to honor their commitments.
“So the best thing for a VC to do for their LPs is wait.”
Limited partners are also watching venture capital investments more closely, after multiple crypto company implosions, including the now-bankrupt crypto exchange FTX.
Venture capital giant Sequoia said in a note to limited partners that it had invested more than $200 million in FTX via two funds, now worth zero. The company said that its exposure was “limited,” Coindesk reported Nov. 9.
“Making a bad investment now could mean this is your last fund as a VC,” Parr said. “It’s safer to wait.”
Theoretically, VCs eventually have to deploy capital at some point, Parr added.
“LPs don’t pay VCs 2% yearly management fees to sit on their hands. But waiting a year is nothing in the time span of VC investment. VC funds have 10-year life spans, minimum. Some have longer.”
When will VCs start investing like they did in 2021?
“They won’t, at least not until there’s a new generation of VCs,” Parr said. “This downturn will be deeply seared into the minds of every active VC & LP working today. Due diligence will take much longer. (This is a good thing.) FOMO is dead. It’s been replaced by FOZO (Fear of Zeroing Out).”
But Parr predicts VCs will come roaring back when the market starts going on a tear again.
Parr has six suggestions for what founders should do right now:
1) “Be profitable. Nothing matters more. VCs don’t want to give money so you last 18 months anymore. They want you to last forever. VCs won’t lose their jobs if you are default alive. They will if you burn all your cash.”
2) “If you’re Series A or later, wait until 2024. Better chance the market has improved by then, and the pressure on VCs to invest will be up much more. You’ll be able to raise at 10x ARR instead of 3x ARR. Nothing feels better — or creates more FOMO — than completely controlling your own destiny.”
3) “If you’re pre-seed or seed, raise as little as you need to reach profitability. $2m pre-seeds are gone. Raise $500k or $1m. There’s enough money out there, but you need to show you understand the market conditions and have a plan for making the money last forever.”
4) “The above rules are somewhat different for A.I. startups. There will be a FOMO race for top A.I. startups. I’m already seeing it. THAT said, if you are A.I. and profitable, you will demand double the valuation instantly. Nothing beats controlling your own destiny.”
5) “For the non-founders out there — make sure you ask questions of any company you join about their balance sheet and runway. If you can, join a profitable company with founders who have good heads on their shoulders.”
6) “For the young or aspiring VCs out there — it’s moments like these that make careers. In this market, it only takes one investment to make your career. It only takes one to destroy it as well. Doing nothing will not give you job security. Need something to show.”
