Bill Gurley: startups seeking funding are starting to lower their expectations

But if LPs are targeting a certain return, then their capital allocation could swing towards including more Treasuries when their interest rate goes up.

Of course that's in a vacuum. In reality I expect many of the asset classes in their portfolio to have some dependence on Treasury rates, which perhaps would result in wider capital reallocations (or change in relative allocations going forward).

We're not talking about a binary choice. Rather, low Treasury rates influence the risk-interest demand curve across the broad market. People are pushed into low yield on low risk investments, which pushes yields lower on marginally more risky investments, &c.

Furthermore, leverage allows you to make portfolios that mimic the risk of other portfolios of riskier/less risky assets. In a theoretically perfect market where the replication can be exact, this fact alone can generate the entire risk curve.

What Gurley is referring to here is actually a level higher up than VCs. He's talking about the people who give VCs their money - Limited Partners or LPs.

LPs are usually very high net worth individuals or funds who invest a portion of what they have in venture funds. VCs are the people who get paid for managing those funds.

If you're responsible for managing the Harvard Endowment Fund (which is larger than the GDP of most nations) you're going to be investing large chunks of capital, and you're going to try and diversify the way you invest it. Say you put 20% into commodities, 30% into real estate, 40% into mutual/hedge funds (the stock market) and 10% into tech via VCs. (Of course, these numbers are complete bogus.)

If the market shifts and all of the sudden you expect really low returns from some parts of the economy, you may shift that money into other parts. So instead of putting 10% into tech you might bump that to 20%.

If that happens across the board VCs will be flush with cash, but unless there's a systemic change in how companies are starting they'll still be responsible for dumping that cash into companies. Remember: if you're a VC it's literally your job to invest the money the LPs give you.

All of the sudden every VC has tons of cash and there aren't enough good companies to invest it in. You might as well invest at really high valuations in the quickly growing companies: It's either that or taking bigger risks on lower quality companies. (Gurley has argued that both of these things are happening, but in this article he's more specifically arguing the former.)

The assertion Gurley makes is that now the market is starting to correct itself a bit. That correction takes place when either the returns are low enough that LPs stop investing as much of their capital in VC or if other investment opportunities heat up and LPs abandon VC to some extent.

Interest rates haven't gone up, so it's not like there's money moving out of VC to make other particularly great investments, but companies aren't being bought very quickly or going public. This means VCs aren't able to give cash money back to the LPs. Therefore the LPs can't reinvest this cash in new companies, and there's still some level of skepticism around whether these companies will return what they're "worth" on paper at the end of the day. If they put less money into VC the companies raising money will have a harder time doing so. Gurley is arguing that this is happening now.

Overall VC is a minuscule part of the overall economy - it's basically a rounding error - but how much money is in VC is very much dependent upon how other parts of the economy are doing.

Low interest rates are forcing asset allocators who have high (7-8%) nominal return targets into PE/VC

I go over the logic of this here, many seem to miss it: https://medium.com/@emad/asset-allocation-not-share-prices-w...

(my background: hedge fund manager/strategist with clients like those mentioned in article)

This seems so odd to me. It's like working the odds to stay as VC-funded as possible and basically avoid growing up - and most of them must understand that profitability simply doesn't exist in their model (before they pivot to being another advertising billboard).

The first step is admitting you have a problem, and as long as people keep giving you money, there's no need to admit anything.

Heck. As long as people keep giving you money, is there really a need to make money in another way?

You wrote: "As such, one could argue that the startups have been acting completely rationally by taking advantage of the willingness in the private markets to invest at exorbitant valuations."

In the words of Clay Davis from The Wire: "You think I have time to ask a man, 'why he givin' me money?' Or 'where he gets his money from?' I'll take any motherfucker's money if they givin' it away."

Many VC's encouraged startups to raise as much money as they could while the getting was good. That is a good move for the VC's (raises the value of their shares) and the entrepreneurs (they get more money). But everyone should have known that interest rates were going to rise in the future, and that's the one trigger that will truly change the capital market.

I agree. The strategic need for startups to exist in the Bay Area combined with the cost of living/cost of talent has caused costs to soar, necessitating more funding. Combined with easy money, this has been a tinderbox waiting to blow for some time.

But if there were no easy money then those startups would have less money to spend on salaries as well. If we believe that easy money benefits established companies more than it does startups (not sure) or funded startups more than bootstrapped ones (almost certainly) then the net effect might be bad.

But an 'arms race for scarce talent' probably benefits a large proportion of the readers here, and harms a much smaller proportion.

Gotta push the market down before the next round of buy-low-sell-high!

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