A look at how interest rates put pressure on venture capital firms and stifle innovation

by MMC
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This article was submitted to TechCabal by Yacob Berhaneco-founder and CEO of Pariti.

Founders… we are not the only ones struggling.

Over the past 18 to 24 months, we have heard the term “dry powder” over and over again. Basically, the perception is that after years of record fundraising, venture capital funds are sitting on huge piles of capital that they have not deployed. The perception, in many From my conversations with founders, is that investors are sitting on cash and watching us flounder. The reality is far from that.

I wanted to write this for my fellow founders who may not have time to do research or may not have had exposure to capital markets like I did during a banking stint investment. Hopefully this is helpful and informative in linking together some of the different threads on this topic.

Sorry for the jargon; I’ve done my best to link to helpful resources to help you along the way.

This is not a pity party for investors; it’s a reality check for us. No one will come to save us. We need to build resilient businesses that solve big problems, with great distribution/moats, adapt to the new world of AI, and continue to grow at exceptional rates. If that sounds ridiculous, it is. But so is believing that we can build a unicorn and change the world, right?

Mario Gabriele, writing in The generalist, once said: “If the 2020s have one ultimate message, it’s that we live in the most chaotic timeline. This is the era of superbugs and superbubbles, of lockdowns and collapses. Welcome to the Roaring Twenties: a decade of chaos.

The quote above captures the essence of what it means to be a founder, especially a millennial. We grew up in rapid boom-bust cycles and now we need to come to grips with the reality: Until interest rates come back down, there is no reason to believe that capital dollars- risk will begin to accrue at a high rate. It would be great to watch the Fed Funds Futures Contracts and being able to predict rates, but I’d rather spend the time and effort figuring out how to build a phenomenal company that solves huge problems. This allows us to endure the difficult times so that we can appreciate the good ones to come.

Topics to unpack

  1. New normal for founders and investors. The definition of a good deal has changed dramatically. Yes, as founders, I feel like the goalposts have now moved – they have! But not just for us. Venture capital firms are struggling to raise. If you check the data, you will see that it is hard here for everyone. If you are a VC who does not have a good track record of DPIxTVPI or a few strong brand exits, raising the next fund is an uphill battle.
  2. Focus on protecting portfolio value. General partners (GPs) have had and will likely continue to focus on the bird in the hand rather than over-indexing on the birds in the bush, thinking (and/or hoping) that their portfolio founders will realize this. . Funds have capital set aside in their portfolio to ensure their winners and potential winners survive (as best they can) and be able to weather the storm (hopefully). It’s also a new world for many venture capitalists. Many GPs are new to this game and have never been through a recession cycle, just like us founders, so we are all learning in real time.

We must also remember that our investors have other investments and only about 30 days a month. So, a good exercise for us founders is to look at the size of the fund in relation to the amount invested, consider what they are pricing you at and the likelihood of you returning from the fund or not. It’s not easy, but this level of sobriety is essential, especially in these times.

  1. Opportunity cost for calling on capital. Depending on the limited partner (LP) base (institutional, endowment, pension fund, HNWI), they may have different capital requirements. In an environment where you can earn over 500 basis points (bps) without risk and be able to get out of money markets in a matter of days, this begs the question: why invest in illiquid asset classes like stocks? start-up phase, particularly when your public equity markets are falling by over-indexing the equity portfolio in general?

And now?

Ask yourself: Is this my life’s work? If so, you are playing an infinite game. There is no shame in the losses that result, as long as you operate with integrity and are truly obsessed with solving a problem that can improve the lives of others. It’s all a series of experiences. Another thing that is important to align with your management team and key investors is: Are we heading towards a living, investable or acquireable default? Be clear and decisive here.

Remember: build something that matters to people. We obviously all want to be investors, unicorns, etc. Sometimes it’s not planned. Sometimes it is. What is within your control is being customer-focused and obsessed with solving problems using data and feedback. HAS Parity, we realized that by co-creating with our community around data x AI models, we can change the capital and talent markets and enable people to make money. Overwhelming their efforts with AI does not replace them. Some of our community representatives are earn more every month than the average GDP/inhabitant in Africa. Are we satisfied? No! But every day I’m reminded that there are people in the world grateful for what we’ve built, and that reigns supreme above all else. For those of us going through this cycle, I believe the businesses we build will be some of, if not the most, transformational businesses the world has ever seen.

If you would like to learn more about this and other related topics register here. I’ll be interviewing founders/investors over the next few weeks to better understand these current events and get different perspectives, from early-stage to growth-stage founders and investors.

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