Illustration: Aïda Amer/Axios

As more and more venture capital-backed startups acknowledge having received Paycheck Protection Program (PPP) loans, many have wondered why their VCs didn't bail them out.

What's happening: It comes down to the deep pocket fallacy. Venture capital funds are not the same as the rich uncle. They have their own investors, or limited partners, to whom they owe a fiduciary duty.

  • Many of these limited partners, such as pension funds and college endowments, are dealing with their own liquidity and allocation troubles. We've only heard select stories of LPs defaulting on capital calls, but imagine the strain if a VC fund chose to simultaneously "bail out" most of its portfolio companies.
  • There also may be some technical issues, in terms of there not being enough fund capital reserved to bail out existing portfolio companies. Or limits on the amount that can be invested per company. Cross-fund investing is usually considered legally dubious — which means that a VC firm's new, largely uninvested, cross-vehicle may not be available for portfolio companies in the last fund.

Cushion: Venture capital isn't designed to create massive capital cushions for startups, which is why so many are feeling the crunch.

  • Whether a startup raised $5 million or $50 million in their last round, it's usually intended to last less than two years in a normal economic environment.
  • Some more conservative founders insisted on large rainy day funds, or got very fortunate in the timing of their last infusion, but most startups aren't sitting on piles of cash.

Capitalism: The cold hard truth is that VC funds aren't social safety nets, per the legal agreements signed with their investors.

  • PPP is explicitly written to keep employees on payroll. VC fund documents are explicitly written to generate financial returns for limited partners.
  • VCs may be able to make a compelling case that keeping all or most employees is the best way to conserve long-term value, and thus worth taking the short-term hit. But, in many cases, that's a tough fiduciary argument to make — particularly when so much startup hiring is done to meet growth projections that have been slashed.

The bottom line: It's certainly true that too few startups and their investors were adequately prepared for a major economic downturn, let alone a calamity. Lost value will, in many cases, be deserved. It should force tough, productive conversations about future actions and structures.

  • But, for now, this is about the livelihoods of those who don't get to make those decisions. Venture capital funds raised before the crisis are unlikely to be their most efficient or effective payers. Even if we wish they were.

Note: None of this is specific to Axios, which received and then returned a PPP loan.

  • Both decisions were above my pay grade.

Go deeper: Mnuchin says SBA will do "full review" of PPP loans over $2 million

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