VC, NFP or F&F - what's a startup to do?

Nice post by VC and blogger Fred Destin, explaining the dynamics at work in the VC industry at the moment:

A number of effects are at work here:

- LPs closed for new business: Many funds are either failing to raise or are deciding to postpone their fundraising. Hence they have to live for longer with the cash at hand. That means reduced investment pace and a generally defensive stance.

- Companies in need: Companies are needing more cash. Even late stage "safe" businesses suddenly revert to spending hundreds of thousands a month as they grapple with a tough economy and expansion plans gone wrong. Exit are few and far between and the alternative sources of finance have dried up (venture debt, public markets etc).

- Optimistic funds chastened: Most funds were under-reserved for this crisis. In other words, the ratio of reserves held back versus capital invested was too low. Now, as you decide to hold back say $2 per $1 invested, all of a sudden cash planning shows a massive gap. The result is ruthless portfolio triage and weakened syndicates.

- Uncertain future: most of all, lack of visibility on when this crisis ends and when liquidity returns block decision making and risk taking

- Existential crisis: the industry must shrink, the GP's often need to reinvent what is they do, the legitimacy of the sector as a whole is in question. Behind the short-term angst are some good questions about the abundance of fairly undifferentiated venture capital out there chasing fairly undifferentiated deals in shrinking niches. But more on that some other day.

Net-net, the result is a two speed market where

- Atlas / Accel / Balderton/ Index / Wellington / Greylock / fill the blank are fighting hard for the "must-do" deals (wonga, just-eat, spotify etc)
- 75% of companies receive a firm but polite "no thanks, unless this is a recap" and are having to rely on their existing syndicates

(Of course those hot startup chasers are setting themselves to overpay and look dumb later - I hear Joost had to beat 'em off with a stick, and now look.... so, Wonga? Spotify?)

As he points out, the industry is seeing some rays of hope (the new Birch/Hoberman fund, for example) but overall it feels to Fred (and me) much like 2001-2003. As Fred says, "For most companies out there in the "grey zone" (worthy but not obviously hot), it's tough and it's going to remain that way."

Now in theory, one of the big changes today is you can start a company on an order of magnitude less money. That is true in the very early stages, and for specific types where the users can be suckered into doing a lot of the work, but for most TMT (Telecoms/Media/Tech) companies the largest costs are in the wetware, not the software or hardware, and salaries haven't dropped hugely from 2001 last time I looked.

Maybe that is why we are seeing "Not For Profit" outfits now intruding into all sorts of areas previously considered commercial, simply because there is more grant money than commercial money around today for startup types (and there is far less legal oversight of NFPs - so this will all end in tears, but that's for another article)