What incentives does inflation create in Venture Capital?

Inflation is high.

What does that mean for those in the world of Venture Capital?

Some quick musings about impacts and incentives regarding funding rounds.

This is a macro view and definitely is not tailored advice!

Startups:

• Costs are going up - staff, offices (if you have them), software etc.
• Your last funding round won't get you as far as you thought.
• You might have to make an annoying change with your annual inflation assumption in your model).
• You might need to consider earlier price increases for your products/services

What are some fundraising incentives?

Prices going up mean you may have to raise sooner - but pricing larger rounds at today's prices is going to be painful from a dilution perspective if inflation is anything other than transitory.

The recent spook in the market seems to be affecting Series A+ firms more than early stage (where deployment of capital looks broadly consistent/increasing).

How should you raise if conscious of inflation? Well - convertible notes are arguably optimal (assuming you can negotiate a good upper cap/no cap ideally). You may be raising sooner

VCs:

• Assuming valuations go up (market forces have led to some scare and some reduction in valuations however) - Your last fund won't get you the % or diversification that you thought you might.
• Inflation may be yet to feed through to founder assumptions (and it's more likely founders take the hit - negotiating power still sits with those with capital).
• Incentives for VCs are however skewed toward deploying more sooner - when inflation feeds through to valuations (not if)
• Portfolio companies will need to raise again sooner - do they have the metrics that help raise that round? Who has just raised a Fund that reflects the new paradigm?

What are some fundraising incentives for VCs?

If the Fund is fixed for the foreseeable, there's an incentive to deploy capital sooner. This will hopefully mean that the % of portfolio company ownership means the maths of power law returns still work out (without relying on significant outliers to the norm - no matter what we think about our stock picking skills).

Deploying sooner also means there's less of a risk on diversification (prior to inflationary impacts on valuations - there's only so much this can move as incentives have to balance between founders, existing investors and prospective investors).

The paragraph above is also how I'd want (as a founder) my VC to be opening doors to relevant investors for my next round sooner - there's a much greater chance with more relevant investors at the table, that one of them goes on to raise a new fund reflective of the new state of play - those are the ones I'd want my investors to be bringing me into.

Would love your thoughts - this was hastily penned and recorded in 25 (ish) mins. There's a lot I haven't covered. Let me know what you think in the comments :).