Inflation, Startups and VCs (Part 1)

I wrote last September about the competing views around deflation versus inflation.  Interestingly, about 9 months later we still seem don’t seem to have real clarity on the subject.  Over that time we have approached deflation but there has also been a ton of government intervention, which has prompted op-eds predicting future inflation and even a new fund run by Mark Spitznagel (a long time collaborator of “Black Swan” author Nassim Taleb) to bet on inflation.  On the other hand have been responding blog posts like this one by Paul Krugman and op-ed pieces like this one by Alan Blinder arguing that inflation is not a threat.  In a second post I will dissect the arguments a bit, but first why should startups and VCs care at all?

It is hard to remember when we last had meaningful inflation (in the late seventies and early eighties) and so most entrepreneurs and VCs active today (myself included) don’t have a good sense of the implications.  Generally, it turns out to be much harder to run a business during inflation especially when the business is equity-financed such as VC-backed startup or a VC fund.  Expenses tend to inflate faster than revenues – especially true of course for pre-revenue startups.  The amount of venture funding in your bank (or the size of your fund) on the other hand are fixed.  In 1980 when inflation peaked at nearly 15% that would have been a serious consideration.  Even at say 10% annual inflation, a $100 million fund is not really a $100 million fund at all considering that the money is put to work over a 5+ year-period.

Deflation, btw, is not pretty either but it tends to harm existing businesses more than startups.  So as a startup or a VC you should care about whether we might face a return of inflation.  In Part 2 of this post, I will describe why I am (cautiously) optimistic that we don’t need to lose sleep here but also should not dismiss the potential entirely.