Venture capital firms in Massachusetts have billions of bucks in their bank accounts. In just the past month, two local firms, General Catalyst Partners and Flagship Pioneering, announced that they had collected an additional $3.4 billion in fresh capital, which they plan to use to back fast-growing companies.
Could VC firms like these be players in an emergency stimulus program, pouring some of those billions into the local economy to give it a boost?
The short answer is no. But the longer answer offers insight into how venture capitalists think in recessionary times — like 2000, when the dot-com bubble burst, or 2008, when the mortgage crisis hit.
VC firms are doing five things now, and none of them involve writing checks to startups faster.
The first step is assessing the health of the companies they invested in prior to the coronavirus crisis and resulting economic shutdown.
“When this all started happening, we had daily meetings, and we went through our portfolio of startups to ask how much runway every company has,” says Greg Dracon, a partner at Boston-based 406 Ventures. “Runway” refers to the amount of time a company can survive before it runs out of money. Dracon says his colleagues took a worst-case-scenario position, assuming that the startups in 406’s portfolio might bring in no new revenue in 2020, and even see existing customers go out of business.
The goal, Dracon says, was to work with the companies to cut their spending so that “they have 18 to 24 months of runway, to, hopefully, see the back end of this.” Spending cuts might include reduced pay for senior people, layoffs, less spending on marketing, and lease renegotiations.
The second thing VC firms are doing is analyzing how much money they’ll need to use to support those existing investments, versus finding new startups to fund.
“VCs who have been doing this for a long time know to over–reserve, because they’ve lived through economic cycles before,” says Maia Heymann, founder of Converge, a Cambridge VC firm. “You reserve more money for each company than you think you’ll need. It’s Venture Capital 101.” But Heymann says she has already heard through the grapevine about some VC firms that haven’t kept sufficient capital in that rainy day fund. That will create stress when startups go back to their group of previous investors, only to find that some can’t keep supporting them.
Third, some VC firms are simply acting more cautiously. Firms may never have invested in a company without having spent time with the founders face-to-face, Dracon says. “It’s still a business where you like to build relationships,” he says. It takes such a long time to build a successful company that “it’s hard to not have built up the trust ahead of time.” (Dracon says that he is on the precipice of investing in a cybersecurity startup whose founders he has not met face-to-face, but that’s a first for his firm.)
For some smaller checks, Krishna Gupta of Romulus Capital says he could imagine moving ahead without having met the founders of a startup in person, but for bigger commitments, “the human element matters a lot,” he writes via email. “I need to have conviction that the founders are open to feedback, they have a passion that comes from somewhere within, they can be resilient.” Gupta adds, “Would you be fine dating and marrying someone entirely virtually?”
In a typical year, a venture firm might invest in roughly six to 10 new companies. At Boston-based Polaris Partners, which invests in technology and life sciences startups, cofounder Terry McGuire says that his firm has already made four new investments in 2020, and that he expects that number to reach eight or 10 by the end of the year. Every deal requires intensive research and reference checks — a process that firms don’t like to rush. And, McGuire says, rather than speeding things up, “I have heard stories of VC firms saying they’re not doing any deals for the next six months.” Why? “I can’t think of any good justification,” he says, “but maybe it’s like the first time you see a car accident — you pull over and slow down.”
One recent deal that Polaris was involved with, alongside General Catalyst: putting $2.2 million into Umbulizer, a startup out of Harvard. Umbulizer is working on a low-cost ventilator initially designed for use in the developing world — but which may have broader uses in responding to the COVID-19 pandemic.
Fourth, as soon as there’s the perception that money will be harder to raise in the months ahead, venture capital firms get more leverage when it comes to negotiating how much equity in a given startup $1 million of their money will buy. Stock markets evaluate the worth of public companies on a second-by-second basis, but the process of a venture capitalist and entrepreneur coming to an agreement about how big of a stake that $1 million will get is slower. Startup valuations were sky high as recently as February, and “it takes entrepreneurs a while to come back down to earth,” Dracon says. That could be another reason deals happen more slowly in the remainder of 2020.
Fifth, venture capital firms worry about their own future. If the companies they’ve invested in die, struggle, or simply take longer to go public or be acquired, all that gets recorded in what you might think of as the firm’s win-loss record. Firms with a poor record find it hard to raise capital the next time they need it. (Their money tends to come from wealthy individuals, pension funds, and university endowments, who give it to them in the hopes of earning a positive return.)
For those five reasons, Dracon says, “I’m guessing we’re in for a pretty significant slowdown overall in Boston” when it comes to VC investing activity.
And no one with whom I spoke believed that VC funding could perform any meaningful role as economic stimulus. The dollars that VC firms invest relative to Massachusetts’ gross domestic product is “minuscule,” says Larry Bohn of General Catalyst, while “the numbers of people unemployed is staggering and will take a lot of time to recover.” At best, Bohn says, VC investing activity may help keep unemployment rates in tech and life sciences below that of other industries.
“Sorry to be a downer,” Bohn says.