03.04.2020

The truth about Start Up investment in the COVID world

This afternoon I attended a great web panel hosted by sifted.eu and got some amazing insight into the live the investment landscape for early stage business.

Dealroom.co reported that funding rounds have plummeted 22% over the past 2 weeks, rumours of slashed valuations and term sheets being pulled are swirling, and yet VCs protest that they remain open for business.

So what’s the truth?

My take on what I heard was that although in the weeks just gone VCs have been focused on their existing portfolio, they have now turned to the open market. You might also be surprised to hear that pre-revenue and product rather than sales focused businesses might find themselves at a distinct advantage – something at odds with how founders instinctively feel.

Read on for my full notes with hints and tips of what founders can do to be ‘investment ready’ today:

What’s been happening in VC land?

  • Record levels of VC investment pre-covid
  • In EU a heavy reliance on foreign investment (Asia and US)
  • Now rumours that foreign investors absent as focused on home markets portfolio in first instance

What have VCs been doing since Covid?

  • Firstly focused on existing portfolios, checking cash and investment requirements and plans for existing businesses
  • Understanding government support and impact on their portfolios across jurisdictions i.e. international businesses and/or portfolios
  • Kicking the tyres on their current businesses first
  • Only now are they returning to their deal flow and new investment

Are VCs avoiding certain businesses/sectors/markets now post-covid?

  • Yes and no. Deal flow assessed on a question of whether Covid is a ‘blip’ in time or a new normal. Context of the business and sector is important.
  • Perhaps a focus on businesses that are considered more recession proof in the early days
  • More of a focus on how a businesses is valuing growth and what does ‘growth’ mean in the short, medium and long term. The definition of growth might be shifting temporarily
  • VCs will be focused on deploying their funds but not rushing anything
  • An individual VCs reaction and appetite is largely dependent on their portfolio make-up

What can we expect from valuations and investor behaviour?

  • Expect investment slower in earlier stage
  • Expect reductions in value – some benchmarks in the public market have seen a 25-40% correction in value
  • Take a look at valuations from c3-4 years ago when things were more stable and less overinflated
  • Many businesses of ALL sizes are overvalued
  • Serial entrepreneurs are voluntarily reducing their valuations to avoid a flat fundraise at the next stage i.e. active planning for the future round by tweaking the valuation now
  • In a bull market you’ll see bull valuations and bull multiples, we must therefore expect the opposite in this bear market
  • Paradox that there is however a big chunk of cash sitting and waiting to be deployed

How can founders navigate these valuations?

  • Try to maintain a sound cap table, don’t accept mass dilution as future investors will still want to see founders aligned to the business
  • Ensure you’re in an auction situation to drive price and a variety of options but be careful to ensure that you go for HIGH QUALITY money
  • Founders should eb careful of accepting the highest valuation – often these investors are the ones that will be the first to call the money in when the going gets tough. If the better investors that you can work with is at a lower price then it’s worth a serious consideration.

Are different stage businesses more susceptible to difficulties in fundraising now?

  • For seed, and high growth stage these will find it easiest to raise cash. Lots of PE funds, etc. are vying for this and have funds set up.
  • If you’re doing series A at cheque sizes >£10m it’ll be very tough
  • There are only 5 funds in the EU that are >£250m for early stage businesses, so if your cheque size is big it’s going to be very competitive

Other misc comments

  • In the EU business is incredibly dependent on government help, the EIF represents some 20-40% of all capital deployed, we’re about to find out if Modern Monetary Theory is true (that governments can print as much money as they like, but it doesn’t really impact anything.
  • Family offices may be pulling back slightly. Although the public markets correct, the VC investment stays the same i.e. they tend to invest a FIXED percentage of their portfolio in VC style funds, and the BALANCE goes to public markets so as the public markets go through mass correction the % available to VCs becomes much less.
  • Family offices likely to be a bit more skittish and short term

Will we see disruption post-covid?

  • Obvious disruption in healthcare, and education (direct to consumer)
  • We’ll see maturing of other industries like food delivery where there will be shakeout
  • A big question mark over whether consumer behaviour changes will become pervasive e.g. consumption linked to climate change, OR a huge boom of hedonistic excess?
  • Will coworking become a thing of the past, or will people want it more because they’ve been restricted?
  • It’s far easier to be part of a rising tide, so keeping your eye on these trends will be big

Does this mean no investment for pre-revenue businesses?

  • No, sales led businesses are actually the most sensitive to the current situation
  • Best business right now is Saas / Software led product – stay dark for a longer time under the radar simply focused on product and then emerge at just the right time
  • Revenue is really a validation indicator that the product is acceptable to the market, early market validation will now become more important but necessarily by demonstrating sales
  • If a business is making very good sales now they could see the opposite effect as things return to ‘normal’ i.e. it could be distress purchases and therefore sales not a good solid indicator
  • More important is the measure of engagement and net retention to demonstrate the underlying and continuing customer base

What can founders do to help themselves?

  • Avoid becoming a super lean start up that cuts back on everything but goes nowhere, you might save the business from going under but the lack of achievement may be just as dangerous
  • Don’t worry about having the ‘perfect’ investment rounds. In 2008/9 investors understood that things had gotten a bit messy so at future rounds they expected a little complexity. There will likely be a ‘2020’ style willingness to overlook things that would normally be problematic
  • Be creative – investors will be looking to see not that you just cut costs and weathered the storm, but that you were resilient, creative in your problem solving, that you took swift action. Demonstrating how you pivoted to maximise opportunity and reduce risk is essential.
  • Key your eyes firmly on government support and what you can do to protect the business
  • Make tough decisions – investors will look back at how quickly you acted and whether you were able to do the best things for the business
  • Use your time wisely, investors will be curious to see how you used your time and for what

James McMillan is co-founder and CEO of myNexus Platform, smart-matching entrepreneurs and investors.