COVID-19 will kill a ton of startups (or so it will seem)

Yes, I’m still predicting-away, though the pandemic is having some impact on the direction in which this narrative is going. Today’s column on startups and venture capital, for example, wasn’t even on my original list of predictions. Just as the financial markets will use this catastrophe for a reset, so, too, will Sand Hill Road, which has pretty much stopped investing and is now deciding, instead, who to kill?

The psychology of venture capital doesn’t work the way most people think. That’s because it is an industry based on failure: most startups -- the vast majority -- fail. That means most VC investment decisions are wrong. There is simply no way of getting around this fact. You can’t call yourself a VC if you don’t make investment decisions and you can’t make investment decisions without being wrong most of the time. So succeeding as a VC is not just a matter of finding good companies, but also avoiding bad companies and managing your portfolio for the greatest possible perceived total value.

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Before I get too deep into this I want to explain that the type of VC I am writing about is the classic venture investor who has a lot of guts and is looking for the big win. There is another type of VC, which I’ll call a LumpenVC, who does just the opposite. LumpenVCs are parasites on the venture ecosystem who succeed by copying the smart kids. A LumpenVC  hopes for his or her entire career to fall into a tennis or golf friendship with a VC superstar who will allow the LumpenVC to participate in investments, often with no idea where their money is even going.

This is an artifact of a venture market grown too big. But we’re not talking here about LumpenVCs who take bites of B- and C-Rounds. We’re talking about real VCs. And you may be surprised to know that real VCs generally see each new startup less in terms of its potential as an individual investment than its potential impact on the VC’s existing investments.

There was a time, for example, when the superstar company in the portfolio of Mike Moritz at Sequoia Capital was Yahoo, so he asked himself not just whether this next startup was a good investment in its own right, but also what impact it might have on Yahoo? Mike’s wealth lay in the proven success of Yahoo, so he tended to see Internet investments in terms of their impact on Yahoo. Five years later the field had changed and Mike’s question was about the impact on Google, his new darling. And today it’s probably in terms of some other company I don’t even know.

So every VC investment decision takes place in a context that changes from firm to firm and that explains why their risk profiles seem to vary so much. They look different only from the outside, while from inside the portfolio there’s a lot of very rational balancing taking place.

Most startups fail, which means most VC investments fail, which means that at some point it will be possible to see each portfolio company as one that the VC is managing toward success or failure, which is to say death. At that point, you see, the VC knows they made a mistake and that a portfolio company must die. From that moment on they are trying to figure out how to be least hurt (or how to benefit most -- that’s the dream) by the inevitable death of their investment.

Enter the pandemic. Startups are like any other companies so their staffs have been sent home to continue working over Slack or Zoom, trying to at least appear to be still in business. Hopefully, it will be for just a month or two, but who knows? At this point, every VC is deciding which of their investments to prop-up with more money, which to let die, and which to fold into another?

Some portfolio management comes through forced marriages -- mergers that may or may not actually help the acquiring company but generally do help the VC who has invested in both. Big successes suck up little failures under the prodding of VCs who sit on both boards. The little company actually failed, but it doesn’t look like that to the outside world. Another common word for this kind of nonsensical purchase is that it’s an acqu-hire (buying a company not for its business or IP but to get the big brains who work there). Some acqu-hires are legit, but others are like Katherine the Great forcing her servants to have sex in front of her.

Back to the pandemic, which was difficult to foresee if you aren’t a biotech VC, but as an event like a hurricane or wildfire can’t be ignored and sometimes can be taken advantage of.

A lot of old grudges are settled during catastrophes: was that an accidental drowning during the hurricane or flood or was it murder? Oh well, with 30 other deaths tonight we just don’t have time to even think about it…

So expect an over-sized response among startups to COVID-19. Almost no new venture investments will be made until the medical outcome is clear. But during that same time, A LOT of startups are going to go under -- more even than you might expect -- because they were going to die anyway and this is a great chance to blame that inevitable death on the pandemic.

The good news in this is that failure is rarely punished in high tech startups, because if it were punished nobody would ever have a job or succeed. With their portfolios cleaned-up a bit, coming out the other side of this debacle the VCs will also have more money than ever to invest. But not this month and probably not until late summer.

So until then don’t quit your day job.

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