Hearing about how hard it is to raise from VCs right now? It’s because the VC’s investors control the money–and they want it to be hard.

A recent article in the Financial Times reported that VC’s have a record amount of “dry powder”–more than $300bn. Dry powder is money that VCs have raised from their investors, limited partners (LPs), but have not yet deployed into startups.

But in 2023, despite the record, deployment fell to a 5 year low. Why?

Several reasons.

The first is that while the broader tech stock market has recovered from a nearly 35% drop in 2022, the startup market hasn’t recovered. The IPO ETF, an index of companies that recently IPO’d, is still down 45% from its 2021 peak. Late-stage startup valuations have not adjusted accordingly and so fewer deals are happening.

But early-stage rounds are also down even though these are companies that won’t even attempt to exit for 5-10 years. While some founders still have unrealistic expectations, many understand the party is over and are willing to accept lower valuations.

This is strange, then. Shouldn’t the VCs want to invest when the market is down–buy low–at least in companies that are realistic on valuation? Presumably the market will eventually recover. Isn’t now actually the best time to invest?

Probably. But I think there’s a subtle reason they don’t. Right now, many LPs don’t actually want the VCs to be investing in new startups at a rapid clip.

When VCs raise a fund from their LPs, they don’t actually require the LPs to send them the entire fund commitment upfront. The dry powder isn’t actually in the VC’s bank account; it’s a contractual commitment for the LPs to send the VCs funds when they do a deal. Until then, the money remains with the LPs.

And money with the LPs can get a guaranteed 5.5% in Treasuries right now. Or way more in asset classes like structured credit. LPs are not necessarily thrilled about investing in an asset class–VC–which is still down nearly 50% from peak.

But don’t LPs have a contractual obligation to fund the VCs if they want to do deals? Sure. But LPs still have a lot of leverage.

For example, an LP could call up the VC partner and hint that if the VC invests rapidly the LP will stay away from their next fund. Even if it’s not this explicit, VCs usually implicitly understand their LPs’ investing goals. And there aren’t that many LPs–you don’t want to get a reputation for crossing your investors.

Does this apply to every VC? Of course not. Deals are still happening, though at a much slower pace. And in many cases it’s the VCs, not LPs, who have chosen to pull back.

But, in general, the above logic is why I and many others think that VC investing won’t really come back until interest rates fall, even though on paper there’s so much dry powder. Even if it’s the best time to be investing as a VC, the VCs don’t actually have the money–the LPs do. And right now many LPs feel they have better things to invest in.