What we’re getting right and wrong about coronavirus and VC investing

It has only been nine days since I wrote an overview of the state of VC investing during the rise of the novel coronavirus pandemic.

And what a week it has been: The markets have triggered circuit breakers for an unprecedented third time, a global economic depression seems in the offing and the Trump administration is now proposing upwards of $1 trillion in fiscal stimulus on top of the Fed’s hundreds of billions of dollars in quantitative easing.

My God, there is so much news.

Given how much has changed in just the past few days, I wanted to revisit my original advice and go over what is still true, what has turned out to be wrong and what is trending one way or the other as events unfold.

Let’s get started.

As I have said ad nauseam this year, VCs are in a hyper-competitive market like we have never seen before. There are more VCs, VC firms and VC dollars in more geos worldwide prowling for the next startup than ever.

The coronavirus outbreak has not changed this basic thesis in the market.

Still true, but this could change very fast. One of the major arguments I made in my overview of how SARS-CoV-2 will change venture investing is that the public markets are intimately connected to venture investors, even at the earliest stages. Bad markets are going to dampen VC investing for a variety of reasons explained in the original article.

VCs do indeed have enormous quantities of “dry powder,” meaning that they have closed on a fundraise that affords them the right to invest dollars on behalf of limited partners in the coming years. Today, according to most reports, that dry powder is in the tens of billions of dollars just domestically in the United States. VCs ultimately want to invest that money, but there are some nuances here that could change this situation rapidly.

First, LPs may outright ask for their money back. Dry powder is not money sitting on the balance sheet of a firm, but rather capital reserved by a limited partner that is “callable” by a VC when they need to use it to close an investment. With massive declines in the stock market though, it is almost inevitable that some LPs are overstretched and can’t make their obligations if asked. Which means that some VCs will face acute pressure to resist asking for that capital in the first place as LPs figure out their own portfolio and cash management responses.

Second, VCs will have to double down on many of their existing portfolio companies if the fundraising environment drastically dampens in the coming months. They will spend their dry powder on their existing businesses rather than fund new businesses. It’s arguable whether this strategy ultimately produces the greatest returns for investors, but this is the path that most VCs generally take in a downturn. Putting more money into reserves means less money for new investments, which will hurt founders seeking funding.

Finally, as some investors leave the marketplace, the overwhelming pressure to fund deals before they slip through an investor’s fingers is going to dissipate. Investors have a lot more time now to consider their options, which means longer funding cycles and probably ultimately fewer checks being written.

So while there is ultimately a lot of capital searching for quality returns, that doesn’t mean that the fundraise market will continue in the way it has the past few months.

I have heard from a smattering of VCs (not enough to call it a trend mind you, but still) that they actually intend to double down in the coming weeks on investing.

Still true, but for how many VCs? This is a mainstay on VC Twitter, and everyone loves to point out that Google thrived in the dot-com bubble of the early 2000s. Everyone may be “open for business,” but the real question is just how many VCs are in a position to actually back up their words with cold, hard cash.

The nuance I would add to my analysis from before is that the earlier your venture round, the more likely it is that this will hold true. Pre-seed and seed capital seems likely to continue to be bountiful, since those small checks can buy relatively large ownership. But already, I am hearing about Series As that are getting pushed back and even some larger seed rounds getting put on ice.

It seems very likely to me now that anything later than Series A is going to be very tough in the next weeks and months as VCs retrench and catch their bearings.

Take a company like HashiCorp, which raised $175 million at a more than $5 billion valuation. There is, at least in my mind, no way that round could be done today with the full understanding of the coronavirus in mind. How will the company match investor expectations with the shrinking multiples on SaaS revenues happening today on the markets? The growth world is going to have a true reckoning soon.

Is it possible to fundraise today? Absolutely. Will it be as easy as before? Almost certainly not. Will valuations sink a bit? Yes, almost certainly. But should all that worry you? No, no and no. You should be going into every fundraise with the mentality that it will be arduous, that no additional capital will ever be found again and then be pleasantly surprised at the result. This one is no different.

The message is right, but valuations are going to just sink. So here is a mea culpa: I wrote, “Will valuations sink a bit? — Yes,” and that is almost certainly a terrible understatement. Valuations are going to nosedive and the $5 million on $40 million pre-seed round of yore is going to look quaint for a while here. I expected 20-30% declines in valuation, but I would up that today to 50-60% in the earliest stages based on feedback I have heard.

If you have to fundraise now, I would go in with the full knowledge that the valuations you are going to see are going to be unpleasant and paltry. Plan accordingly and make sure to broadcast to investors that you have realistic expectations about where the market is and what investors are going to be willing to agree to.

All that said, the rest of the message stands. Every fundraise can fail, and while the probability of a fundraise right now failing is going to be higher, that shouldn’t change the basic dynamic that seeking more capital is never a guarantee.

The biggest challenge today is going to be maintaining momentum during a fundraise. A lot of investors are going to wait and see, and you must identify those investors and cut down on your contacts with them.

Yes, and I would double down on this advice. It seems clear to me that everyone is open for business and yet transaction volume is going to be hit hard. So you must triage VC interest to find those that are just going to delay, delay, delay and those that see opportunity and want to act.

There are not going to be dozens of investors waiting to invest in your company today like there were just a few weeks ago. You might only have a handful in fact, but dollars in hand are worth a lot more than promises in the wind. If you need capital and have a term sheet in hand that you may not like, now is the time to start locking in capital and moving forward and not regretting the past.

It’s a changing situation, so it is hard to give long-term advice here. Instead, I would emphasize that you meet in-person with those you can, work with those who only want to do so virtually and do your best to identify who is just wasting your time and who might actually move forward with an investment in spite of the lack of an in-person meeting. My guess is that the number of VCs on your final fundraise list will be smaller, but there will still be competition among them, assuming the core of a business is solid.

Obviously, no one is meeting in-person. One novelty, particularly for the smallest startups, is that a lot of VC firms are going to experiment with new processes for shepherding investments through their partnerships. There might be an opportunity to seize where you become the first all-digital investment, the first no-in-person meeting founder the firm has backed, etc. There aren’t going to be infinite unique milestones like this, but all firms are going to have to find new ways to handle this situation and you might as well be the guinea pig.

Given that social distancing looks like a continuing situation for the near-to-medium term, the strictness of the policy is going to force more VCs to get over their “meet founders in-person” requirements. It’s impossible to know how that will shake out in terms of investments right now though. Perhaps they write no checks, or maybe they write even more. Perhaps in the best-case scenario, more diverse founders are funded as the well-known biases of in-person meetings are evaded. I don’t know, no one knows, and we are all going to find out together.

So with that, I will leave with my conclusion from the analysis, which holds forever true:

In short then, the novel coronavirus is adding huge ambiguity to the futures of a lot of startups. But ambiguity is what founders navigate, literally every single day. This issue, like every other issue that comes up in the activities of building a company, is no different. Ask for advice from other founders and advisers. Listen to the feedback people tell you. Get creative about how to connect with new folks as quarantines and lockdowns persist. Husband your capital, but realize that now might be a moment of growth rather than merely stagnation.

Do what you can with what you have. That’s all you can ever be expected to do.