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Why Venture Capital Doesn’t Scale Part 4: How VCs Make Money as Big Businesses Win the Pandemic

Welcome to the fourth article in my blog series about how VCs make money. So far, we've explored good investments and bad, and we've taken a close look at the unicorns and white whales (like the WeWork scandal). We've covered how VCs can artificially prop up a company for a time and how choosing the right partners/founders/investor personalities can affect everyone's bottom line for years to come.
government bailouts venture capital

In my last piece, we talked about management fees and carry and broke down the "Two and Twenty" rule. Today, we're going to look at the businesses that endure a wavering shore because they're backed by the US government or "too big to fail."

We'll talk about how the COVID-19 pandemic is causing the largest wealth transfer in human history. We'll also look for the underdogs: the businesses and communities hit hardest. They may be facing extinction! And finally, I'll predict how the industries backed by the US government will weather this storm and how VCs make money through it all. 

COVID-19: The Largest Wealth Transfer in the History of the World 

In June 2020, Jim Cramer of CNBC's "Mad Money" said the COVID-19 pandemic led to one of the largest wealth transfers in world history. I've always agreed with this statement. And looking back today, we can put a finer point on those numbers.

Small, privately owned businesses were hit incredibly hard by the COVID-19 pandemic. You're probably already aware that personal care industries (like salons and barbershops), hospitality/travel, and full-service restaurants took the hardest hits. This seems a natural outcome among states and counties with curfews, social distancing orders, stay-at-home orders, and the like. 

Then, as the 2020 holiday season played out, we saw small retailers losing their opportunity to recoup losses via "Black Friday." 

It's also natural that we'd see the use of social media balloon. Online gaming, online education, online entertainment services like Netflix, and eCommerce all grew exponentially. It just makes sense. (I'll get to those details in a moment.) But our first concern is for the small business owners, their employees, and their families, right?

Look closer and see other worrisome trends that have been exposed thanks to the pandemic. 

Small Businesses Struck Down by Coronavirus

Consider these statistics:

My first thought is: that's the natural progression. This is a historical accident, a fluke. These small businesses are the unfortunate and unavoidable casualties of the pandemic. 

A Record-Breaking Black Friday: The Big Dogs Come Out on Top

The Friday after Thanksgiving has been a holiday shopping sensation in the US for decades. On November 28, 2020, US consumers spent a record-breaking $9 billion — making it the most successful Black Friday ever. That's an increase of 21%, and it's the second-highest day of retail sales in US history, only topped by 2019’s "Cyber Monday" for overall sales. 

Smartphones were the hot seller, accounting for $3.6 billion in sales. 

We saw more deep, competitive discounts happening online during the weeks between Thanksgiving and Christmas, and that drove more online sales. It all makes sense. Between social distancing requirements, infection fears, and a lack of small businesses to shop, big-box retailers like Walmart and online sources like Amazon made a killing in 2020. 

They're not alone. Per msnbc.com, big chains like CVS Health, Home Depot, and Lowe's have earned at least $1 billion more in profit in 2020 than in 2019. And I doubt many of their essential employees experienced a meaningful raise. It's starting to look like COVID-19 might bring the end to small businesses in the US, for a time.

Is COVID-19 the Killing Stroke?

For decades, big corporations have been taking market share from small businesses. The corporations at the top consolidate into ever-bigger megacorporations. For instance, back in the 1980s, half of the retail shopping took place in independently-owned shops. Today, less than one-fourth of retail shopping happens in mom-and-pop stores.

VC-Backed Companies Enduring the Pandemic

From 2002 to 2017, Home Depot and Lowe’s almost doubled their joint share of the home-improvement retail market, from 42 to 81 percent. But even before the COVID-19 pandemic, more than half of all groceries purchased in major metropolitan areas came from Walmart. 2020 amplified these changes, and both small businesses and weaker corporations won't outlast the pandemic. 

Newer ideas like grocery delivery and meal delivery app services are growing thanks to the pandemic. We can surely expect brilliant medical innovations to follow, and hopefully a big boost in medical facilities.  

A few new government-backed industries will surely arise, and that's how VCs make money, too. Thanks to management fees and carry, venture capitalists will continue to get rich because of them. 

On Bailouts and Government-Backed Industries: The Basics

government bailouts venture capital
Government bailouts might slow down the descent of a few key industries.

The idea of government bailouts and government-backed industry isn't new. Since 1792, the US government has stepped in from time to time to help businesses that were "too big to fail." It happened during the Great Depression after the stock market crash of 1929, in the Savings and Loan bailouts of 1989, and again in 2008 in the Great Recession and housing market crash.

  • A staggering example of US government bailout has been the response to the COVID-19 pandemic, which led to a severe contraction in economic activity and employment.
  • President Donald Trump signed the Coronavirus Aid, Relief, and Economic Security Act (CARES) on March 27, 2020. It provided more than $2 trillion of aid to American individuals and their businesses.

And sometimes, the US government steps in with industrial policy

A Few Notes on US Industrial Policy and the Green New Deal From the VC Perspective

Setting aside the struggling small businesses, now, in the wake of COVID-19, venture capitalists see an opening for government-backed research and development, and eventually manufacturing and installation, for three impressive sectors:

  • Green energy development and infrastructure per the ”Green New Deal
  • Medical innovation 
  • Hospital or medical facility development

As a venture professional, this is an exciting time! Remember that venture returns don't always correlate with the public markets; that’s not how VCs make money. Downturns like COVID-19 give VCs a different level of choice and leverage. Sometimes we can deploy capital at better valuations, be invited to join otherwise private deals, and become even more selective with our investment criteria.

Final Thoughts on How VCs Make Money

I know a lot of smart venture-backed companies are deep in planning and recalibrating their operations since COVID-19. How VCs make money is changing, but it's not falling apart. Every boardroom in this nation is speaking to management teams about contingency plans. They're refocusing on mission-critical projects, extending their cash runway, and doing more with less, whether that relates to capital or personnel. 

Some of the world's most dominant companies were built in times of tremendous adversity. Cadillac became a luxury brand during the Great Depression. Google and PayPal weathered the dot-com bust. Airbnb was built on a financial crisis that led to "staycations" and a craving for inexpensive travel.

So sometimes, incredibly challenging markets create a cradle to grow outstanding innovation. That’s how businesses grow and how VCs make money. I'm confident that more winners of this ilk will present themselves in the wake of COVID-19. Whether your innovation is in cleantech or another clean energy service or product, I'm here to help. Let me know what your take on the upcoming year is and what role VCs will play in it.