VC funds, like startups, have their own unique set of cashflow issues that aren’t well known outside of the investor community. Funds rely upon their own investors – “limited partners” – to provide the capital that then flows into their portfolio companies. These limited partners into VC funds can vary widely, from wealthy individuals making $100,000 commitments to sovereign wealth funds committing $50m and larger checks.
But when a fund advertises that they closed their new $300m fund, it doesn’t mean on day one $300m is wired and everyone cracks the champagne. This really just means that the investors have signed a commitment to fund their portion as it’s needed.
For example, an investor making a $10m fund commitment actually invests this over a series of smaller checks around 4-5 times per year over the first 4-5 years of the fund. Otherwise the investor holds onto their own money until it’s needed by the fund. It makes no sense to just sit in a VC’s bank account.
In difficult economic times it’s not always possible for these investors to come through with their commitments. In some cases, VC funds’ own investors will call to tell them they cannot fund anything at the moment, saying “please don’t make any new calls for capital until we give you the green light.” This means no new investments or even pulled term sheets as VCs realize they cannot actually fund a deal they may have loved the month before.
Europe has a particular problem with this scenario as a far greater proportion of funds are backed by family offices, wealthy individuals and corporate investors. These kinds of investors are more exposed to individual industries and thus can run into their own financial difficulties. In the US by comparison, funds are more commonly backed by pensions, endowments and other institutions who face far fewer day-to-day funding problems.
European funds will be challenged in the coming months as corporates will be skittish in funding their existing commitments and families and individuals have to put themselves first in managing their own cashflows and this will most certainly lead to lowered valuations and fewer term sheets.
We should expect a chill in the market for at least the next 6 months as VC funds and their own investors work out their cashflow issues and determine what can be funded and what capital they have available to do so. Founders must prepare for this early and ask the tough questions to properly inform their own decisions in operations and fundraising. And if companies have direct corporate or family office investors, they should not take for granted that these entities may have difficulty funding earlier commitments given the higher priorities of keeping themselves afloat first.