‘We literally couldn’t fundraise’: Why wealthy VCs won’t save struggling startups

Tech startups have been pilloried for taking coronavirus loans. But for many founders, reality is more complicated than the Silicon Valley caricature.

‘We literally couldn’t fundraise’: Why wealthy VCs won’t save struggling startups
[Source images: BeeBright/iStock; insspirito/Pixabay]

Criticism of venture-backed startups that took coronavirus loans has exploded since the government’s first round of stimulus funding was exhausted on April 17. With millions of mom-and-pop businesses laying off employees, some have asked why buzzy tech startups with powerful patrons should be among the first to receive forgivable Small Business Administration loans. After all, can’t venture-backed startups simply ask for more money from wealthy investors?


Of course, it’s more complicated than that. There’s no doubt that some larger companies have abused the program, and many may end up giving the money back. But it’s also true that there are many different kinds of venture-backed startups, in various stages of their development, with varying access to capital. Despite the backlash, many startups say they really did need federal loans to stave off layoffs and stay afloat.

The Paycheck Protection Program, which the government just reloaded with $310 billion in additional funds, is meant to provide emergency relief to small- and medium-size businesses. Low-interest loans of up to $10 million are forgivable if the recipient lays off no employees for eight weeks after getting the funds. But the SBA left it up to applicants to determine whether they could borrow the money “in good faith.”

That ambiguity immediately set off a noisy debate among founders and venture capitalists about whether venture-backed startups should apply. “I think the issue is that the government hasn’t provided a clear definition of ‘need,'” says Brad Srvluga, a general partner at Primary VC. “So startups that have many months of cash on the balance sheet but also are burning money consistently are struggling to understand if they should qualify.”


Abusing the PPP loans

This confusion may be part of the reason so many companies applied for the forgivable loans when they may not have needed the money. The SBA hasn’t released the lists of companies that have been approved for the loans, but anecdotally we know of some questionable cases, including the steakhouse chain Ruth’s Chris and Shake Shack.

More than 200 publicly traded companies were approved for loans totaling $750 million in the first round of PPP, The New York Times reports. As a result, the Treasury Department is now strongly suggesting that loan money be returned. Ruth’s Chris has said it will return its $20 million loan. Harvard University, Stanford University, and Princeton University will return loan money, as will the Los Angeles Lakers. Shake Shack and Sweetgreen have also announced plans to return funds.

I think the issue is that there’s no clear definition of ‘need’ that’s been provided by the government.”

Brad Srvluga, Primary VC

There’s been so much abuse that on Tuesday, Treasury Secretary Steve Mnuchen said that the SBA intends to audit many of the PPP loans, and public companies, or companies “with liquidity” found to have made false certifications in order to qualify, may face criminal liability.


Based on the sheer volume of applications, it’s also likely that some VC-backed startups took the loans for other purposes than avoiding layoffs. A New York Times article by Erin Griffith and David McCabe Monday suggested as much: ” . . . start-ups, which last year raised more than $130 billion in funding, have sometimes turned to the government loans not for day-to-day survival but simply to buy useful time,” the two write. “In Silicon Valley parlance, they want to extend their ‘runway,’ or cash on hand, to a year or more.”

But salaries and runway length are inextricably tied. If “runway” means the time a startup can operate before running out of cash, part of what defines the runway’s length is the rate at which the company is spending money on salaries. One way to preserve runway length is layoffs—exactly what the SBA loans are meant to prevent. Most of the specific examples of VC-backed borrowers Griffith and McCabe cite in the story had seen their businesses demonstrably harmed by coronavirus, had already held layoffs, and conceivably could lay off more people as the recession deepens.

Facing layoffs

As the pandemic has spread, startups have been hit hard. Many operate in industries like retail, hospitality, travel, and entertainment that have been directly hurt by the crisis, according to a new study conducted by the Center for an Urban Future and Tech:NYC. Dan Unter, CEO of the hospitality industry startup Kitch, is quoted in the report saying his company has seen a “100% decline in sales.” Startups that specialize in travel bookings have seen their businesses evaporate quickly, says Oliver Libby, managing partner of Hatzimemos/Libby Holdings. Hicham Oudghiri, cofounder and CEO of data company Enigma, says that his company’s sales “will easily drop at least 50%.”


“We had two major customers push back multimillion-dollar deals until at least the first quarter of 2021,” says Jeff Crystal of the solar charging company Voltaic. “We are a 10-person company so that is a lot for us. Those deals were probably 60% of our 2020 planned revenue.”

The SBA guidelines say the loans should be accessed only as a last resort by companies that have no other access to capital needed to continue paying salaries. For some venture-backed startups, the choice was that simple—either take the loan or lay off staff. But for others, it was a little more complicated.

One startup founder who asked to speak anonymously says his company had been operating on capital from a seed round it raised last year, and had just begun raising its series A round of funding in February when the specter of the virus descended.


Everybody just pulled back. We literally couldn’t fundraise any longer.”


“We thought we would be able to fundraise before the summer, which is typically the VCs’ down period, and we were having great conversations with lots of different VCs,” the founder tells me. “But then COVID-19 started getting a firm grasp on the VC market and everybody just pulled back. We literally couldn’t fundraise any longer.”

Unable to raise the next round, and facing dwindling cash reserves, the company applied for and received a PPP loan. That helped it avoid laying off any of its 15 employees.

But it wasn’t just salary costs that were shortening the startup’s runway—it was the cost of doing well. Demand for the startup’s products, which are aimed at the small business market, has picked up in the past few months. To service the demand, the founder told me his company has had to scale up its operations, and that costs money, too. Some of the PPP money, then, will be used to finance the company’s growth in the absence of additional venture capital.


VCs in “triage mode”

These struggles have extended to venture capital funds. As the virus took hold in February, VC firms shifted their operations into “triage” mode, where helping existing investments survive the crisis became the name of the game. Naturally, the portfolio companies they’ve invested in are now getting the most attention, and in some cases, emergency cash.

One East Coast venture capitalist, who also asked to speak anonymously, said they had provided additional capital to a portfolio company that still applied for a PPP loan and also held layoffs. The company used the loan money to minimize the size of the layoffs, the person said.

For other portfolio startups, that kind of VC attention and cash is far from guaranteed.


Venture capital often cannot be used to backfill a startup’s lost revenue.”

Justin Field, National Venture Capital Association

“Venture capital often cannot be used to backfill a startup’s lost revenue,” says Justin Field, the SVP of government affairs at the National Venture Capital Association. “[T]he notion that VC capital can be freely used today to sustain current operations is a basic misconception of the fundamentals of long-term VC investing.”

That’s because the way VCs disburse capital from their funds is carefully planned out. “Much of the capital must be reserved for new company investments over the course of years, as well as for financing additional future growth milestones of companies in which the fund has already invested,” Fields says. Sudden major crises—like pandemics and economic collapse—aren’t necessarily factored into the plan.

And the VCs don’t make the plans for the capital by themselves. They have to answer to their own investors, a group of limited partners who provide the capital for the fund from which the VC will invest. Those limited partners have a say in the kinds of startup companies a VC invests in. The limited partners would much prefer that the VC invest money to finance growth activities in startups, like expanding research activities, building a factory, or hiring a sales force—not helping avoid layoffs.


A VC’s ability to inject emergency cash into a startup also might be limited by the equity terms of the fund. When the VC invests more money in a startup, they’re also buying more equity in the company. The limited partners typically don’t want the VC to take a controlling position in a startup. They often prefer to distribute their risk exposure by taking smaller equity shares in a larger number of startups.

The PPP’s tragic flaw

The PPP’s first $349 billion tranche ran out 13 days after the program opened, leaving many small businesses in the lurch. Now, with applications for the PPP open again, scrutiny over whether startups are applying is increasing. But the real problem with the PPP is that it had no system for making sure the most needy borrowers were served first.

Mnuchin said that the program’s “first-come-first-serve” basis would guarantee that the most needy would be served, but that’s not how things turned out at all. While many Main Street businesses struggled to get their paperwork together before the loan money ran out, tech startups saw their loans quickly approved.


A new study of the first round of loans showed that the biggest determining factor for being served was whether or not the applicant had an existing relationship with one of the banks participating in the program. That automatically left some of the most needy borrowers out in the cold. Tech startups usually have relationships with banks like Silicon Valley Bank, one of the institutions that processed applications for the SBA.

Even for existing customers of the bank, there may have been a bias against smaller borrowers. “It takes the same amount of effort to approve a $4 million PPP loan as it does a $400K PPP loan,” says Ryan Denehy, CEO and founder of the virtual IT support startup Electric, in an email. “As a result, many banks moved their largest customers ‘to the front of the line’ in the first wave because they only had so many resources to put toward approving these loans.” Denehy’s company initially considered applying for one of the SBA loans, but eventually decided against it.

Now the tech community is thinking about the same thing as the rest of the country: When and how can the country reopen for business, and how long will the economy take to recover? For many, the debate over PPP is largely over.


“The chatter in startup land has really died down,” says Denehy. “The folks who really needed the money seem to have applied, and those who needed it and didn’t get it will be applying again.”


About the author

Fast Company Senior Writer Mark Sullivan covers emerging technology, politics, artificial intelligence, large tech companies, and misinformation. An award-winning San Francisco-based journalist, Sullivan's work has appeared in Wired, Al Jazeera, CNN, ABC News, CNET, and many others.