How venture capital follows the economy down and curtails innovation

https://www.nber.org/papers/w27150

by hhs • 6 years ago

93 24 6 years ago

nber.org

mc32• 6 years ago

When times are good you can take some chances; when times are lean, you place less risky bets?

What do they suggest?

CerealFounder• 6 years ago

Thats the main false assumption about venture. Given the stage of venture investing, there is way less true evaluation and understanding of risk going on than they care to admit.

vikramkr• 6 years ago

VCs seem perfectly content to point to a power law curve and "admit" that in their view, "true" valuation is impossible and irrelevant, risk is so high most companies are going to fail, so all they care about are the outsized wins. They then turn around and put in a ton of warrant provisions and downside protection anyway, but they at least claim publically that power law rules

adaisadais• 6 years ago

I think early-stage VC’s should take a Keynesian approach and should invest more heavily in recessed periods.

With 35+ million Americans unemployed there are more founders available than probably ever before. In the next 6~ months rent prices should decrease (or mass vacancies depending on your area). Now is the time to invest in the economy.

Not when it’s too expensive.

patrickk• 6 years ago

I think early-stage VC’s should take a Keynesian approach and should invest more heavily in recessed periods.

Why would they do this? They're not a charity. They'll only invest more if they think there's more returns to be had.

With 35+ million Americans unemployed there are more founders available than probably ever before.

That may be the case, but VCs much prefer to bet on previously successful entrepreneurs, sometimes on their new project sight unseen. The amount of unemployed bartenders or airline employees getting VC money will be very low.

MattGaiser2• 6 years ago

With 35+ million Americans unemployed there are more founders available than probably ever before.

The job losses are overwhelmingly in low skill, low education required jobs. Their experiences and domain knowledge are in industries that are currently crippled.

Most just wouldn't have the skills or expertise to found scalable companies.

_curious_• 6 years ago

Skills and expertise can always be learned and acquired.

foobiekr• 6 years ago

we aren't there yet, though. a lot of successful startups were founded during recessions. everything is cheaper in a recession - office space, perks, salaries, equity %, etc. this helps every $ go farther.

but we aren't there now and may not be this round. it's a unique event. I can't imagine starting a company now and having the whole team be remote when your #1 goal in your series A is to execute as fast as possible and communication is one of the key limiters.

gnicholas• 6 years ago

Benefits of starting a company in a recession: lower rents, cheaper salaries.

Downsides: lower consumer and business spending.

If you’re trying to start free and grow that base, then perhaps it’s good to start in a recession. But if having paying customers is important, the headwinds could be outweigh the tailwinds.

Another consideration: does your company align with how people are reallocating their time/money during the recession? If you can get a piece of recession spending, good for you. But if you’re a general-purpose product then you’re probably in for a tough ride.

marcosdumay• 6 years ago

If you are trying to disrupt a market, a recession is exactly when your consumers are most willing to switch into a supplier with lower margins.

If you are going into a winner takes it all market, a recession will give you the lowest amount of competition. (But then, it's just because it's contrarian, if everybody invested in recessions, this wouldn't be true.)

MiroF• 6 years ago

Benefits of starting a company in a recession: lower rents, cheaper salaries.

This recession is potentially so short and wages are so sticky that I'm not sure that this actually will pan out.

surfmike• 6 years ago

On the whole though you’d expect less people to have enough money to be an early stage VC during a recesssion. I think those that can afford it will definitely be looking for opportunities.

pge• 6 years ago

If VCs were investing from a balance sheet or their own accounts, I think this would be true. And my experience in the 2000/2001 and 2008 recessions was the funds that had ready access to capital invested significantly (and got good returns) in those down cycles. The issue, however, is the LPs. The capital that VCs invest comes from LPs that are large investors like pension funds and college endowments. These investors have very meaningful exposure to the public markets and broader economic trends, and when those take a big hit, the LPs put pressure on VCs not to make capital calls (reducing access to capital). In addition, LPs are often very reluctant to increase their exposure to VC/PE in down turns and commit more to illiquid assets. As a result, VCs don't want to try to raise a new fund when LPs are pulling back. So they try to stretch out the current fund as long as possible. Last, in a down turn, existing portfolio companies may not have access to outside capital, so funds may end up deploying or reserving more capital into the existing portfolio rather than to new investments.

Those external drivers combine to result in a slower pace of investment for VCs during a recession.

rfreytag• 6 years ago

Given the important role that VC plays in financing breakthrough innovations in the economy

I would like to see a comparison of RoI of: government, business, and VC technical research. I am not convinced that the results will favor the VCs.

arrosenberg• 6 years ago

Agreed. It seems more likely that VC replaced government investment, but with a profit motive, rather than a national or societal motive.

say_it_as_it_is• 6 years ago

The source of the last few months of data is Pitchbook. Is this a comprehensive, reliable source for early deal financing?

hhs• 6 years ago

It looks like the authors relied on several sources. They write:

“To analyze how VC deal activity responded to the COVID-19 pandemic and attendant economic crisis, we use data from Pitchbook, CB Insights, and Capital IQ. We tabulate VC investment deals in U.S.-based startups by industry and sector using the Pitchbook and CB Insights data. Pitchbook has the advantage of broader coverage, while CB Insights has the advantage of detailed company descriptions, which enable us to assess changes in financing for particular types of businesses in sectors especially hard-hit by the crisis.”

olivermarks• 6 years ago

This would be a good time for the US (and other countries) Small Business Administration to play a far more nurturing role in order to help restart and start new businesses. Many VC investment strategies are designed to destroy existing business and create network effects monopolies that only benefit a few people. Aside from VC investment being a tiny fraction of overall new business funding there is greatly decreased interest in innovative new ideas/risk taking as this report suggests.

SrslyJosh• 6 years ago

Aside from VC investment being a tiny fraction of overall new business funding there is greatly decreased interest in innovative new ideas/risk taking as this report suggests.

And when our economy only works for a small fraction of the population, that means fewer startups, less diversity of ideas, and fewer successful VC-backed startups.

davidu• 6 years ago

"To analyze how VC deal activity responded to the COVID-19 pandemic and attendant economic crisis, we use data from Pitchbook, CB Insights, and Capital IQ. We tabulate VC investment deals in U.S.-based startups by industry and sector using the Pitchbook and CB Insights data."

Pretty early to analyze this data. I find that both these sources take 20+ weeks to get close to accurate, and they are never really perfect.

FWIW, my view is that I think recent deal activity has been very high at a16z, Sequoia, Founders Fund, and others but that's just from where I sit.

andrewla• 6 years ago

There's some sort of paradox at work here, and it's not clear where it is breaking down.

Current interpretation of antitrust law in the US is very pro-consumer, which is a horrific problem, because it's supposed to be anti-concentration-of-power. That is to say, selling at a loss to drive down prices and then raising them once you've put your competitors out of business is only illegal in the last step -- the undercutting is not an issue. It should be -- the very act of anti-competitive behavior, like driving out competition or putting up barriers to competition in the form of uneconomic pricing, is written right into the text of the laws. But consumers are helped by low prices, and once the competitors are gone, who is going to say whether the prices are better or worse than they should be; there's no benchmark.

The main problem with this viewpoint in my mind is that this is clearly unworkable -- a continuous pump-and-dump can't work; eventually it has to come crashing down. Arguably it is now crashing down, so that's fair, but historically we still have things like Amazon in the digital world, not to mention the traditional big-box retailers that have driven out anything resembling competition.

So do we need to have a working anti-trust regime in order to counteract this? Or will such monopolies naturally fail if they are exposed to external stresses? In some ways that depends on the theory of why we are seeing this happen; why there hasn't been a huge undercutting of these companies. Or maybe the problem is just that we're looking at the wrong timescale; and given long enough these will collapse under the weight of new entrants in to their markets.

One theory is that regulatory capture is the root of it; that once you have established your market position by burning money, you can then start spending money on codifying your business practices as the required standard for all competitors. Regulators like to deal with fewer entities rather than more, so the hobgoblin of a foolish consistency start to overwhelm more common-sense ideas in the space.

Another is that the power dynamics shift and allow you to treat government as your protector; on the state and local level looking for special treatment (tax advantages, preferential zoning), at the federal level sometimes even direct protection or pork barrel spending or even just being able to influence tax policy.

Another theory is that once you are large enough, the various tax and money-moving games that aren't worth it for small companies start to scale up; it costs you a million to legally hide or disguise your profits, so until you are looking at revenues at that scale you're screwed, so getting over the next size hurdle is the only thing you can focus on.

Some might say that this is just a consequence of corporate person-hood and limitation of liability; that in the desire to ensure that corporations pay taxes, we accidentally tacked on too much power by treating them as entities rather than collectives, and all such entities are intrinsically psycopathic.

The last theory, and the one that I most dislike (though it may well be true) is that this is just where capitalism ends up if you allow it to grow unfettered; r > g, and all that jazz.

I don't find any of these 100% convincing, though.

How venture capital follows the economy down and curtails innovation

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