Rescue capital for GPs & next order effects from the pandemic & special situations season

Whenever we do come out of this crisis, investment firms may need solutions to problems we’re not yet able to imagine. Right now, GPs and LPs alike seem mostly content pressing pause, reflecting, refining, exploring new hobbies, etc. But the world is never static. It changes.

LPs could have trouble funding capital calls, making it difficult for GPs to pay down credit facilities or even fund their operations. LPs could pull back completely and flee to perceived “safety”, leaving GPs unable to raise additional capital for new investments. Mid-level professionals at GPs could see their carried interest from potential exits of portfolio companies disappear, and realize they no longer have a financial incentive to stay. And of course, the many scenarios outside the limits of our imaginations that we’re not prepared for.

However, when those problems do appear, the solutions will rush in. There’s an unfathomable amount of capital waiting to be invested that will find its way to those problems and solve them for expensive prices. Though we’ll see whether those problems are actually solved, or if the capital will just be incinerated.

Some reading:

  • Fred Destin’s thread on “how one venture capitalist thinks about the pandemic from a fund standpoint”. I worry about people not thinking through the second, third, fourth, nth-order effects that will follow March’s unprecedented revenue shock. Fred succinctly describes these effects: “Working capital gets hit first and hard, with household wages and consumption following in lockstep. Credit follows naturally.” And, when the consumption hit happens, working capital will take another hit, and the vicious cycle will continue. Perhaps it’s my naivety, but I never considered the American business system so fragile as to only take weeks to break.

  • Lux Capital’s memo on the ‘Four Flows’ that matter. This memo is from March 13th, but the punchline still holds. I do believe consolidation amongst “Minnows and Megas” will play out in venture capital. What’s also interesting is their usage of “Special Situations”. It’s not a term I’d expect venture capitalists to use; it’s one that generalist LPs use as a catch-all for distressed debt, equity turnarounds, and other in-between types of strategies. It tells me that Lux isn’t just waiting for valuations to reset before making new investments—instead, they’re actively looking to provide the creative solutions businesses need in times when liquidity rushes out. In other words, they’re thinking like investors.

Keep staying safe out there. And don’t forget to un-mute on conference calls when it’s your turn to talk.