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Darek Klonowski

Venture Capital
Redefined
The Economic, Political,
and Social Impact of
COVID on the VC
Ecosystem
Venture Capital Redefined
 Darek Klonowski

Venture Capital
Redefined
The Economic, Political, and Social Impact
of COVID on the VC Ecosystem
Darek Klonowski
Brandon University
Brandon, MB, Canada

ISBN 978-3-030-83386-2 ISBN 978-3-030-83387-9 (eBook)

https://doi.org/10.1007/978-3-030-83387-9

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer
Nature Switzerland AG 2022
This work is subject to copyright. All rights are solely and exclusively licensed by the
Publisher, whether the whole or part of the material is concerned, specifically the rights
of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on
microfilms or in any other physical way, and transmission or information storage and
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now known or hereafter developed.
The use of general descriptive names, registered names, trademarks, service marks, etc.
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Thanks be to God
 Preface

Venture capital, which is a global phenomenon that simultaneously main-

tains a strong local character, is defined as the provision of capital and
assistance to private firms by institutional investors. Thus, the industry
is influenced by global capital flows, socioeconomic conditions, and
the political environment, in addition to local economic growth rates,
laws, politics, entrepreneurial dynamics, and institutional infrastructure.
Although the venture capital industry was only founded in the late 1960s
and early 1970s in the United States (U.S.) and the United Kingdom
(U.K.), the total value of private assets under management (AUM) in
venture capital is now estimated to equal $3.4 trillion.
On March 11th of 2020, the World Health Organization (WHO)
announced to the world the existence of novel coronavirus, which was
given the abbreviation “COVID-19.” Specialists from Imperial College
London released an epidemiological model which estimated that in the
absence of strong intervention, the novel virus would result in 7 billion
infections and 40 million deaths globally in 2020 alone. As a result, many
governments around the globe have engaged in wide-ranging restrictive
measures to “flatten the curve”; this practice was initially intended for a
period of about two weeks in order to avoid overwhelming the health-
care system, although these restrictions were subsequently extended to
remain in place for over a year. As a result, economic activities have been
compressed and many industries, sectors, and segments of the economy
have been affected worldwide, including the venture capital industry.

vii
viii PREFACE

Of this book’s many objectives, the primary focus has been its use as a
tool to understand the severity of the novel coronavirus’s impact upon the
venture capital industry. Analysis performed for this book project suggests
that the industry has undergone profound changes since the early onset
of government restrictions designed to halt the spread of COVID-19. A
second area of emphasis within this book is an assessment of the potential
long-term impact of the economic, political, and social restrictions on the
venture capital ecosystem post COVID-response. Thirdly, the perspec-
tives of various stakeholders involved in the venture capital ecosystem,
including general partners (GPs), limited partners (LPs), entrepreneurs,
and other important stakeholders (including the state) are considered,
particularly in the context of the post COVID-response period. Lastly,
the ultimate aim of this book is to answer the question of whether current
changes to the venture capital industry are likely to renew and promote
the industry’s overhaul, or simply perpetuate its decline.

The Book’s Structure

The book is comprised of four sections and nine chapters. Each section
consists of two to four chapters of varying length, with the exception of
the last section, as it has only one chapter. There are 25 figures and tables
to illustrate and provide further support to key observations.
The introductory section of the book is called “Introduction to
Venture Capital and its External Environment in the Age of COVID-
response.” The first chapter of this section focuses on the definition
of venture capital and its characteristics. It provides a brief overview of
venture capital and its underlying concepts that serve as a reference point
throughout the book; it is important to establish this benchmark because
subsequent chapters illustrate changes to the basic concept of venture
capitalism in view of COVID-response. Further segments specifically elab-
orated upon in the chapter include the discussion of venture capital’s
true contribution to entrepreneurial development, as well as some of
the advantages and disadvantages of venture capital as seen from the
entrepreneurial perspective. The first chapter will also provide a survey of
the historical trends in the global venture capital industry over the last 20
years, with particular attention paid to fundraising and investing activities,
including the accumulation of $1.9 trillion in “dry powder.” Additionally,
the chapter provides a background discussion of venture capital returns
in the context of the “promise” made to capital providers (i.e., LPs) by
 PREFACE ix

venture capitalists. The chapter ends by providing a summary of venture

capital and the significant, fundamental challenges it faced in the pre
COVID era, such as its maturation.
The second chapter provides background information on the political
reactions and subsequent socioeconomic consequences of COVID-19, as
well as a general discussion regarding the implications of government
restrictions on venture capital. When the coronavirus initially appeared,
the vast majority of political leaders and public officials around the globe
moved to implement a range of restrictive public measures, mandates, and
orders. Examples of these restrictions include the closure of public spaces
(i.e., universities, schools, government offices, courts, etc.), lockdowns,
stay-at-home orders, travel restrictions, border closures, forced quaran-
tine, limitations on social interactions, social distancing, mask wearing,
and curfews; these reactions are termed “COVID-response” in this book.
Although public officials attempted to introduce some measures to coun-
teract the social, economic, and human consequences of the restrictions,
the effect of these often strict government mandates was nonetheless
devastating. For example, preliminary estimates confirm that in countries
belonging to the OECD (Organization for Economic Co-operation and
Development), economies shrunk by 4.2%, with Spain and the U.K. expe-
riencing the most significant losses. At the height of the economic crisis,
it is estimated that about 500 million people lost their jobs, resulting in
a global unemployment rate of 7.2%. However, the small and medium-
sized enterprise (SME) sector was one of the hardest hit segments of
the economy by far. Furthermore, these restrictions have also negatively
impacted mental health and human social behavior. Drawing on this
important background analysis, the second chapter begins a discussion of
the direct and indirect impact of political, social, and economic changes
caused by COVID-response on the venture capital industry, which is
continued in more detail in subsequent chapters.
The second section of the book, titled “The Venture Capital Industry
Redefined,” is comprised of four chapters. The first chapter of this section,
or the third chapter of the book, describes the fundamental and inherently
complex building blocks of the venture capital ecosystem; it consists of
many critical stakeholders, such as GPs, LPs, entrepreneurial firms, banks,
consultants, bankers, and governments. In spite of its complexity, the exis-
tence of the venture capital ecosystem relies on a delicate balance between
LPs’ profitability, GPs’ returns, and the success of entrepreneurial firms.
If this delicate balance is upset, longer term and more profound changes
x PREFACE

in the industry are likely to emerge, although these trends have beset the
industry for some time and were visible prior to COVID-response.
The third chapter also outlines how COVID-response has redefined
personal relations in the venture capital ecosystem. Since venture capital
is a people-centric business, restrictions have affected virtually every
aspect of GPs’ interactions with entrepreneurs and LPs, in addition to
their in-house operations and relationships with other key stakeholders.
Considering recent disturbances to the already precarious venture capital
industry, the second part of the chapter extrapolates what the future
of venture capital may look like, and describes in detail the stages the
industry may evolve through; these include the global consolidation of
GP partners (i.e., growing emergence of mega funds), global pooling
of LPs (i.e., emergence of global LPs), and the development of more
futuristic structures based on the complete digitization of the investment
process and the wide-ranging dis-intermediation of GPs.
The fourth chapter broadly discusses the major external undercur-
rents that have emerged post COVID-response and are likely to impact
venture capital in terms of both existing portfolio firms and new invest-
ment opportunities. The six major trends detailed include changes to
industrial structures, alterations to consumer behavior, mass digitiza-
tion, the increased role of home as the center of human gravity, public
health apprehensions, and the abolition of the middle class in devel-
oped countries. Available investment opportunities in specific segments
of the economy are also examined as they pertain to each of these key
trends. Lastly, the chapter concludes by illuminating the likely sources
of venture capital transactions in the COVID era, which may include
the privatization of state firms, disposals from major multinationals, and
founders.
The venture capital industry has been under pressure post COVID-
response, which is a trend that is likely to continue in the future; it
is therefore valuable to explore changes to the venture capital invest-
ment process, which are analyzed in chapter five. Normal patterns of
venture capital’s daily operations, deal processing routines, regular habits
of communication, and other tacit behaviors that were previously estab-
lished in the pre-COVID era have been disrupted. Furthermore, state-led
COVID restrictions have affected the venture capital community differ-
ently from country to country, although the venture capital industry
generally went into a retreat-and-hide mode during March and April
of 2020. The situation improved in most countries by June, although
 PREFACE xi

it was evident by the fall of 2020 that the venture capital community
would not be able to engage in its normal processes for the foresee-
able future because of the strict COVID-response measures that once
again emerged. This chapter discusses the many dislocations to the normal
patterns of processing venture capital deals, as well as the challenges expe-
rienced within each stage of the investment process (i.e., deal generation,
evaluation and screening, financial contracting, monitoring, and exiting).
Moreover, the chapter highlights one of the most profoundly affected
phases of the investment process, namely due diligence and monitoring,
and discusses problems related to portfolio firm underperformance and
valuation.
The sixth chapter of this book identifies the future of venture capital
performance (i.e., financial returns) by further analyzing the LP-GP rela-
tionship. The chapter begins with a discussion of fund formation and the
provision of capital by LPs to the venture capital ecosystem. It is stressed
that LPs can contribute to the deterioration of financial performance by
providing capital to suboptimal GPs, performing poor due diligence on
funds, tolerating limited access to information, and so on. The chapter
subsequently discusses the cost of “carried interest” and the provision
of venture capital services to LPs, which are two of the most expen-
sive components within the LP-GP arrangement. Moreover, the chapter
examines value chain analysis, provides another historical look at venture
capital performance, assesses the industry’s return prospects in the context
of a longitudinal study, and outlines the profiles of superior and inferior
GPs.
One of the most important components of the venture capital
ecosystem is the SME sector, which, as noted above, was one of the
hardest hit segments of the economy post COVID-response. Many
entrepreneurial firms were left financially devastated because their profits,
savings, and “sweat equity” disappeared within a matter of weeks or
months following the introduction of restrictive measures mandated by
public officials. Thus, the third major section is called “Entrepreneur-
ship Redefined Post COVID-Response” and consists of two chapters that
focus on the critical issues impacting the SME sector, including its ability
to access entrepreneurial finance.
The first chapter within the third section, or the seventh chapter
overall, concentrates on the entrepreneurial crisis created by COVID-
response; evidence suggests that up to 80 percent of firms were affected,
with about 40 to 50% of firms impacted so severely that they were unsure
xii PREFACE

of business survival. In the U.S., for example, the number of active busi-
nesses declined from 15.0 million to 11.7 million, which represents the
largest decrease in the number of operating firms in the U.S.’ modern
economic history. Furthermore, the harm to the SME sector was indi-
rectly related to the firm size (i.e., larger firms were less impacted by
COVID-response). Although firms operating within the SME sector are
typically flexible and agile in their ability to pivot and generate revenue
through different streams, their capacity to respond was thwarted by the
speed and strictness of public restrictions. The negative impact of public
restrictions has also affected different market segments to varying degrees,
as firms operating in retail, hospitality, restaurant and food services, arts
and entertainment, transportation, fitness, and leisure sectors have been
disproportionately impacted.
The changing landscape for entrepreneurs, particularly in terms of
their ability to procure entrepreneurial finance, is discussed in the eighth
chapter of this book. Research indicates that access to finance is one
of the most critical challenges for entrepreneurial firms, although there
are numerous other issues that have acutely impacted areas of the SME
sector post COVID-response. Primarily, many firms have faced a severe
decline, or a complete loss, of revenue. SME firms have also experi-
enced significant difficulties covering their fixed financial obligations. The
combination of revenue decline or loss with high fixed costs of busi-
ness operations has directly impacted the profitability, cash flow, and
liquidity of SMEs. Secondly, challenges to the businesses’ financial param-
eters have negatively influenced the value of entrepreneurial firms. A third
issue that has beset entrepreneurial firms post COVID-response has been
their ability to maintain personnel; while many firms initially aimed to
sustain their employees, they ultimately resorted to temporary or perma-
nent layoffs due to the firms’ abysmal financial position. The full impact
of these staffing reductions on unemployment will likely be manifested in
the next two or three years.
Additionally, it is noted in chapter eight that many firms from the SME
sector were forced to close while large “big box” stores remained open,
which created an unequal playing field for smaller firms. There is also
preliminary evidence to suggest that the SME sector’s ability to secure
access to entrepreneurial finance is further challenged post COVID-
response, as, for example, data from venture capital firms indicates that
deal volume is on the decline. Business angels have similarly reduced their
financing activities to instead focus on existing investments, while financial
 PREFACE xiii

institutions are expected to encounter problems with existing loan port-

folios and may be reluctant to extend further debt. Although government
programs have developed a wide range of options to support struggling
firms, such as payroll protection, commercial rent assistance, wage subsi-
dies, tax deferrals, and property tax postponements, these measures are
unlikely to adequately supplement the financial needs of SMEs. Further-
more, entrepreneurial firms’ abilities to rely on “bootstrapping” strategies
may be limited; they will need to develop and test new tactics in this area.
On a positive note, the rapid development of fintech has the potential to
financially support entrepreneurial ventures on a wider scale in the future.
The final section, and closing chapter, of the book is called “Revival or
Descent of Venture Capital in the Age of COVID” and seeks to answer
the key question of whether the venture capital industry’s current situa-
tion will lead to its revival or ultimate decline. The possibility of either
scenario (i.e., revival or descent) is discussed in the context of four pillars
of analysis, namely the entrepreneurial sector, GP market, LP segment,
and the state. These potential futures of the venture capital industry are
also compared to the previous evolution of the industry as outlined in
chapter three. This concluding chapter ends with an estimation of the
key statistics in the industry (i.e., fundraising and investing) over the next
20 years.

The Contribution of This Book

The topic of venture capital and private equity is a popular subject for
books, as it has been subject to a plethora of in-depth academic investi-
gations since the industry’s inception in the early 1970s. In the last few
years alone, there have been more than forty books written about venture
capital. And yet, despite the multiplicity of books written in the areas of
private equity and venture capital in recent years, there appears to be a
steady demand for further publications on these subjects. Furthermore,
some of these existing books deal with highly specialized issues in venture
capital, such as buyouts, due diligence, financial contracting, or specific
geographic markets, while still other books deal with venture capital in a
more generalized manner. This project is the first book on venture capital
since the onset of COVID-response.
The book provides many advantages to readers, the primary of which
is its ability to provide further understanding and context to academics,
students, practitioners, and especially entrepreneurs in the area of the
xiv PREFACE

venture capital investment model’s underlying changes post COVID-

response. Additionally, the book aims to outline some of the difficulties
the venture capital industry has faced in the past, as well as new challenges
that have emerged post COVID-response. This book also draws from
multiple sources, including academic studies, industrial assessments, main-
stream media, and directly from the venture capital industry. However, by
providing a hypothesis regarding what the industry may look like in the
future through the extrapolation of long-term tendencies, recent occur-
rences, and trends that were triggered by COVID-response, this book
serves as a valuable tool for academics and entrepreneurs alike as they
seek to navigate the future of the venture capital industry.
Despite its advantages, it is important to note that analytical book
projects written at a time when new trends and undercurrents are just
beginning to impact an industry may have a number of shortcomings;
this project is no exception.

Future Research
Venture capital has been a topic of academic inquiry for a long period
of time. Debate on this subject has been both useful and productive; it
has provided many comprehensive perspectives on various aspects of the
venture capital investment process, including screening and evaluation,
financial contracting, and investee firm-GP relationships. Furthermore,
academic inquiry has not omitted some of the most difficult topics within
the industry, such as the divergence of interest between GPs and LPs,
declining venture capital performance, and the extent of GPs’ effective-
ness in their assistance of investee firms. However, due to current changes
to the venture capital industry as a result of COVID-response, academic
inquiry into venture capitalism is in many ways at a point of partial restart.
There are at least five critical areas of academic investigation that
should be considered moving forward, with the first and most important
area of research undoubtedly related to the redefinition of the relation-
ship between GPs and investee firms. Venture capital prides itself on the
provision of assistance to entrepreneurial firms, in spite of the often imper-
fect nature of this aid. As outlined in chapters three and five, this critical
relationship in the venture capital ecosystem has very evidently been rede-
fined post COVID-response. Thus, the key questions that should now be
asked are as follows: How effective are new modes of online interaction
between GPs and investee firms? Are GPs capable of providing effective
 PREFACE xv

assistance to investee firms post COVID-response, and if so, what are the
crucial areas of assistance that investee firms require? Are there new areas
of investee firm assistance that have been previously overlooked by GPs?
A second fruitful area of new research should explore the future
of venture capital financial performance. In the past, there have been
multiple studies that provide a historical perspective on venture capital
performance, many of which reach differing conclusions as to whether or
not GPs are able to deliver returns in excess of those available in public
equities markets. If GPs are unable to generate repeatable returns that
exceed returns from public equities markets, the entire venture capital
ecosystem would continually be upset and thus subject to LPs satis-
fying their automatic “bucket filling” allocations in the asset class without
much reflection. The vital questions regarding venture capital perfor-
mance should be as follows: What are the key determinants of returns
across various types of private capital investing (i.e., buyouts, expansion
capital, seed and early-stage capital, etc.)? In what ways could the venture
capital change to generate better and more consistent returns? What are
the returns post COVID-response, and how do they differ from those
obtained during other economic crises? Has the divergence between top
quartile performance and the remaining GPs decreased or widened?
The third facet of study that has arisen post COVID-response specifi-
cally relates to the SME sector, which has disproportionately experienced
operational challenges, market uncertainties, financial difficulties, and
problems with financial management, which, in turn, have elevated the
sector’s difficulties in accessing finance. Important questions pertaining
to entrepreneurial finance could include: What are the key bootstrapping
strategies entrepreneurial firms can still rely on, and how has bootstrap-
ping changed for the SME sector? Can fintech fill the intermediate gap
by providing finance to entrepreneurial firms? Are there any new forms of
entrepreneurial finance that are likely to emerge post COVID-response?
What is the new role of the state in assisting the SME sector with regard
to the provision of finance? Are government loan guarantee programs
sustainable alternatives to bank lending?
A fourth area of possible research relates to actual GP operations. As
noted in chapters three and five, in-person interaction has been the bread-
and-butter of the venture capital industry; this form of interaction has
now been entirely redefined. Significant thought should be given to the
effectiveness of GPs’ interactions with their portfolio firms, LPs, and other
xvi PREFACE

important stakeholders, as well as to the overall value of their role in

entrepreneurial finance.
Lastly, since the hypothetical progression of the venture capital indus-
try’s evolution has been outlined, the impact of an expected climax in
the dis-intermediation of GPs should be considered. Therefore, important
questions in this area would be as follows: Is there increasing empirical or
circumstantial evidence pointing to further consolidation of the venture
capital industry? Can we observe an emergence of a handful of GP leaders
in the venture capital industry as has been observed in other segments
of the financial services industry? What are the profiles of these market
leaders and how unique are their operations? Is there evidence to support
the idea that the simplification of the venture capital industry in terms of
its structure would be beneficial? Is there tangible proof of GP consoli-
dation and LP pooling? How would the role of the state change if the
structure of the venture capital industry were to be re-adjusted?

Acknowledgments
I wrote this book during the period of subsequent COVID-response
restrictions (between January and May of 2021), after having read about
70 or so newspaper, magazine, and Internet-based articles on the topic
over the Christmas break; this was a useful starting point in my inquiry,
as it allowed me to dive further into the study of this new and ever-
changing subject. The daily grind of working on this project proved to
be interesting, challenging, and thought provoking. The old Benedictine
monks’ axiom of ora et labora has been valuable in keeping this project
moving forward.
While preparing the initial manuscript, I benefited from informal
(email) discussions with Thomas Meyer (SimCorp) and Mike Casey
(Portico). Discussion with Stephen Richmond (Abris Capital), who has
provided many favors over the years, has also been extremely beneficial; he
has been a go-to person whenever I needed feedback and insight from real
practitioners within the venture capital industry. I have relied heavily on
my previous research, contemplation, and writing while completing this
book, namely Strategic Entrepreneurial Finance and The Venture Capital
Deformation.
I would like to express gratitude to senior administrators at Brandon
University, and especially Steve Robinson, who have supported this book
project through a research appointment. I would also like to thank
 PREFACE xvii

Marissa Stelmack, who has provided careful, detail-oriented, and invalu-

able editorial assistance; Marissa has made numerous corrections to the
manuscript and caught many of my omissions and outright errors. This
level of attention to detail may be difficult to find in young people today.
Of course, any omissions and shortcomings in this book are solely my
own.
I would like to thank Palgrave MacMillan, and particularly Tula Weis,
for providing an opportunity to publish yet another book related to
entrepreneurial finance. I appreciate a quick turnaround on a book
proposal and project approval, as waiting for reviewers’ reports is both
exciting and nerve-racking. Furthermore, I would like to convey thanks
to the anonymous reviewers of the book proposal for their insightful
comments and analysis; this was much appreciated. Lastly, I would like to
thank those who were involved in the financial copyediting and produc-
tion of the project, namely Punitha Balasubramaniam, and Karthika
Purushothaman. Thanks to you all!

Brandon, Canada Darek Klonowski

May 2021
 Contents

Part I Introduction: Venture Capital and Its External

Environment in the Age of Covid
1 Venture Capital Prior to the Age of COVID 3
2 Political Reactions and SocioEconomic Consequences
of COVID: Implications for Venture Capital 37

Part II The Venture Capital Industry Redefined

3 Transformations in the Venture Capital Ecosystem Post
COVID-Response 61
4 Venture Capital Post COVID-Response: External
Environmental Scanning and Investment Opportunities 93
5 The Venture Capital Investment Process Redefined 123
6 Degeneration of Future Venture Capital Performance 155

Part III Entrepreneurship Redefined Post

Covid-Response
7 COVID-Response and Entrepreneurship in Crisis 187
8 Amplified Challenges in Access to Entrepreneurial
Finance in the Age of COVID-Response 217

xix
xx CONTENTS

Part VI Conclusions: Venture Capital in the Age of

Covid
9 Descent or Revival of Venture Capital in the Age
of COVID 247

Index 277
 List of Figures

Fig. 1.1 Global private equity fundraising, investing, dry powder

accumulation, and the illiquidity premium 16
Fig. 1.2 A summary of academic studies on venture capital returns 24
Fig. 1.3 Historical perspective on venture capital and private equity
returns in the U.S. 26
Fig. 1.4 Global perspective on private equity in comparison
with U.S. returns 27
Fig. 3.1 The major stakeholders in the venture capital ecosystem 62
Fig. 3.2 The GP consolidation stage of the venture capital industry 85
Fig. 3.3 The LP pooling stage of the venture capital industry 87
Fig. 3.4 The futuristic architecture of the venture capital industry 89
Fig. 4.1 The key undercurrents in the external environment
and their impact on venture capital 96
Fig. 5.1 The five major phases of the venture capital investment
process 124
Fig. 6.1 Illiquidity premiums across various classes of equity
investing and geographies 165
Fig. 6.2 Conversion from gross returns to illiquidity premiums 166
Fig. 7.1 Value creation in the entrepreneurial venture 209
Fig. 8.1 The evolution of entrepreneurial finance in pre and post
COVID-response conditions 235
Fig. 9.1 The key components of the venture capital ecosystem 248
Fig. 9.2 Fundraising and investing activity in the venture capital
industry up to 2036 274

xxi
 List of Tables

Table 2.1 Political, social, and economic impact

of COVID-response to entrepreneurs and venture
capitalists 48
Table 4.1 Structural and individual undercurrents post
COVID-response 113
Table 5.1 The key changes to the venture capital investment
process post COVID-response 127
Table 6.1 Longitudinal analysis and impact on future venture
capital returns 170
Table 6.2 Types and characteristics of general partners
and simplified value-chain analysis 177
Table 7.1 Redefinition of the key components of entrepreneurial
success 195
Table 8.1 Five areas of financial management and their key
challenges for entrepreneurial firms 222
Table 9.1 Four pillars of the venture capital ecosystem 254
Table 9.2 Evolution of the venture capital industry in the future 267

xxiii
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