How the venture capital ecosystem is shifting and what founders should consider
Given the recent market occurrences, we at RLC Ventures thought it appropriate to outline our thoughts on how the period ahead may unfold. We will take a look at how the overall venture capital industry is shifting, affecting start-ups, GP’s and LP’s alike.
“Tough times never last but tough people always do” — Robert H. Schuller
We thought we’d start on a positive note since everything in recent news has been extremely tough to swallow. A number of industry participants will face extreme difficulties re-entering the market, as companies look to mitigate risk and adapt to the widespread reorganisation of the status-quo. But change isn’t always bad. Whilst we hope working people and governments can navigate a downturn as smoothly as possible, the VC industry has and always will look for disruptors through the tough times. We only need to look back to 2008/09 to see what companies were founded during the Financial Crisis.
With billions of dollars in combined market cap, the aforementioned companies and their respective founders were not deterred by the macro environment — and we anticipate this trend occurring this time around.
VC’s ultimately look to invest in disruptors. As layoffs continue to mount, the societal and economic order of the last decade evaporates, leaving creative approaches and unique business models to flow into the empty spaces. We can only speculate as to what themes will begin to capture mainstream dollars, in a post-COVID world. Remote society (work, leisure, socialising, manufacturing, governing) seems an obvious place to start.
What lies ahead is undeniable uncertainty. Speculation will continue until testing becomes more widespread and concrete data can inform governments globally on the best route to recovery. Until then, measures will continue to be taken to slow the spread of COVID-19, ultimately slowing economic activity, which will lead to the reprioritisation of stakeholder values, and reconsideration of budgets in every organisation globally.
The Funding Side
Since we began with the silver-lining, we should now look to the cloud itself. The US Tech 100 index has fallen over 30% since the coronavirus outbreak and we can, of course, expect this to have an impact on early-stage deal valuation. The pain being experienced in public markets will have an inevitable knock-on effect on private markets also, albeit with a few weeks delay. Decreased liquidity on the public side will lead to a slow-down in M&A activity. Providing transactions are still going though, lower exit valuations (and returns for VC’s and their LP’s) can be expected, and in most cases, routes to exit are quickly slamming shut.
Changes towards the rear-end of a VC funds cycle will also change their approach toward the front, new deals. First and foremost, we might expect to see an increased appetite for deal sharing and co-investment, in order to mitigate risk and reduce ownership exposure. With increased downward pressure on early-stage companies, failure-rates may be expected to rise, and this may call for additional diversification. The impending recession will mean firms may need to share more information and internal knowledge, in order to ensure the ecosystem continues to thrive. The absurdly competitive nature which has been witnessed over the last period of growth may begin to wane, as investors look to one another for reassurance amongst times of uncertainty.
Eric Hippeau, managing partner at New York-based VC firm Lerer Hippeau, experienced what it was like to be involved in fundraising in the aftermath of a recession. Historically, startups might find it difficult to raise capital if recession warning signs are flashing red. But according to Hippeau, “capital will continue to be deployed the same way it was after the Great Recession — cautiously.” Cautious investing will likely mean that the “maybe’s” will be crowded out and only the marquee deals will see daylight.
However, according to Pitchbook data as of June 2019, VC Funds are collectively sitting on $189 billion of “dry powder” which could mean that despite the imminent recession, funds continue to have a lot of capital to deploy.
LP’s and Subsequent Fund Raises
Raising a fund is hard enough as it is, but doing so during a time where extreme capital preservation is recommended to all (including LP’s), it is an enormous challenge. Venture Capital is by nature high-risk high reward, and typical institutional LP’s (such as an endowment fund) might only allocate around 5% of their portfolio to the Venture asset class. Due to the illiquid nature of the game, it can lead to an over-allocation of sorts by LP’s. (See this twitter thread.) This means that newer managers and funds will probably be unable to raise as much capital as first envisioned.
But this is not to say the opportunities to invest in great companies will disappear, but the decrease in capital in circulation will certainly hit those companies without interest from Tier 1&2 funds. Regardless of the economic circumstances, there will always be capital available to companies with a market fit and strong value propositions. As seen in the data below, the amount of capital raised by funds has dropped significantly in both the dot com bubble and the 08/09 financial crisis.
Changes in Attitude
As almost everyone on Earth has undergone some form of isolation, shifts in attitude have begun to occur. Thanks to numerous paid and free applications, we can remain somewhat productive, connected and entertained. Tech investors will look to businesses that are uncovering new consumer/customer behaviour within and following this new paradigm. Although Coronavirus will one day be no more than a footnote in future literature, its impact will not be forgotten for generations.
Whilst outdoor activities have been halted, a number of unique forms of entertainment and exercise have developed and blossomed becoming a norm for our daily lives. Companies keeping us active both physically and mentally through this time at the moment include;
- AloMoves — Online video yoga platform that has seen an increase in it’s user base since the beginning of the lockdowns globally
- Labworks.io — Alexa games developer that includes games classics such as “Would You Rather”, “True or False” and “Trivia Hero” for all the family to enjoy as off-screen, indoor entertainment.
- JoyTunes — wanting to learn that instrument lying in the storage from years ago? JoyTunes will help you achieve your instrumental goals.
- Coursera — Take a course and studying pretty much everything in partnerships with top global companies and Universities
- Masterclass — learn from top chefs, comedians, business moguls, poker players and beyond in short easy to watch online courses
We can also expect more Tech startups to provide solutions to problems that most businesses are facing. Here are a couple of companies redefining typical processes for businesses and healthcare systems.
- Inc42 — is connecting Indian start-ups with expert advice to navigate through this period
- Scribeless — is providing a unique solution to businesses looking to market directly to consumers in this current climate. This is done by providing personalised handwritten letters at scale using robotic technology
- Wingcopter — is developing a versatile drone fleet for deliveries which is proving more vital given everyone is home-bound
- Medloop — offers thousands of patients intuitive self-service features that enable them to navigate their own healthcare pathway and to communicate effectively with doctors
- Walkabout — a US-based startup, tackles social isolation challenges with three-dimensional online workplace simulations
Pivoting is something that will keep companies afloat during this period and those that can ultimately provide genuine value to consumers during this period will prevail.
The UK hasn’t seen such a widespread threat in modern times (although 4 people in Britain did contract Sars in 2002), and so it may be easy to think that we are living in unprecedented times. But as was true in every decade of the last century, as well as 2001 and 2008, bad times don’t last.
Some companies won’t last through the recession. By being pragmatic and capital-efficient, as well as looking to previous economic downturns, a lot can be learnt from those who have experienced similar situations.
So what can be done for now?
Having been through a few online resources, podcasts, articles etc. we have put together some fundamental questions that you should be asking yourselves and your co-founders.
- Do you have as long a runway as you think? Test your assumptions and recalculate.
- Where can you cut expenses without hurting the core business?
- Revenue and cash levels always fall faster than expenses.
- People pulling deals — if you are opening 30 conversations with investors, double it.
- Which VC / Board members will keep you as a priority and help you flourish?
- How will sales be affected in 6 months? 12 months?
- How can you change sales processes to benefit the current climate?
- Are new sales even worth focusing on at this point in time?
- Get a good understanding of your current pipeline and existing customer base. Who is most likely to churn/fall-off?
- Can you achieve the same/more with fewer people?
- 10% fires, same cultural pain as 25–30% but with none of the benefits.
- How important is each individual in the company given the current climate?
- Can you apply for government grants?
- LTV may fall and go back to essential marketing only.
- Re-evaluate customer acquisition models?
- Inform customers about your continued work in this current climate.
- Can marketing efforts be re-structured?
- Should marketing stop fully whilst you focus on building tech?