How 6 top VCs are adapting to the new uncertainty

The COVID-19 pandemic has shifted their pace, focus and interests

As the global economy grinds to a halt, every business sector has been impacted, including the linked worlds of startups and venture capital.

But how much has really changed? If you read VC Twitter, you might think that nothing has changed at all. It’s not hard to find investors who say they are still cutting checks and doing deals. But as Q1 venture data trickles in, it appears that a slowdown in VC activity is gradually forming, something that founders have anecdotally shared with TechCrunch.

To get a better handle on how venture capitalists are approaching today’s market, TechCrunch corresponded with a number of active investors to learn how their investment selection process might be changing in light of COVID-19 and its related disruptions. We wanted to know how their investing cadence in Q1 2020 compared to the final quarter of 2019 and the prior-year period. We also asked if their focus had changed, how valuations have shifted and what their take on the LP market is today.

We heard back from Duncan Turner of SOSV, Alex Doll of TenEleven Ventures, Alex Niehenke of Scale Venture Partners, Paul Murphy of Northzone, Sean Park of Anthemis and John Vrionis of Unusual Ventures.

We’ll start with the key themes from their answers and then share each set of responses in detail.

Three key themes for raising in 2020

The VCs who responded haven’t slowed their investing pace — yet.

There’s likely some selection bias at work, but the venture capitalists who were willing to answer our questions were quick to note that they wrote a similar number of checks in Q1 2020 as in both Q4 2019 (the sequentially preceding quarter) and Q1 2019 (the year-ago quarter). Some were even willing to share numbers.

However, some of our cohort did note that the impact of the COVID-19 slowdown will last for quarters, not months, so we’re in for a long period of change; that many investors matched their Q1 2019 investment numbers in Q1 2020 might not mean much given that many of those deals would have already been in-flight. The second quarter of 2020 should yield an even more interesting figure.

Our respondents did believe that the number of VC deals struck because of the fear of missing out (the FOMO effect) on a winner will decline, as investors double down on diligence and see less rabid competition for deals.

Valuations are coming down some, but it’s not causing friction with founders — yet.

Each startup is different and every deal is complex, but our investor group generally agrees that valuations are coming down. Not too far, mind. Perhaps 10% to 20%, if we’re reading between the lines correctly; only some investors were willing to quantify a numerical decline on the record.

To our surprise, however, the investor group didn’t highlight a clash with founders (yet) about valuations. We had anticipated a bit more friction. For now, however, the valuation declines seem modest and palatable; perhaps if the market keeps falling and startups are asked to endure another haircut, the negotiations will become a bit harder.

Founders are responding immediately to the crisis.

Moving from a risk-on world to a risk-off world does not appear to have taken long, at least according to the investor group in relation to what founders are up to. Founders are cutting spend and extending burn, investors said, smart moves in light of economic uncertainty, potentially longer sales cycles and a more difficult fundraising environment.

For our investors, however, volatility may bring opportunity. Some noted that certain venture fund vintages performed well during turbulent times, so perhaps a less founder-friendly environment will lead to some cheaper equity (and therefore outsized returns) for the funds that do have capital available to use opportunistically. (It’s worth noting here that the VCs were not terribly afraid of LPs freezing up; though some did note that select LPs are less liquid than before and thus perhaps more cautious. That could limit new fund formation.)

Questions, answers

With that summary behind us, let’s get into the interviews. As a note for the curious, we put work into sending questions for these surveys to a diverse set of venture capital investors. What we cannot control, however, is the results that come back. This time, the people who responded were all men. We’re going to redouble our efforts in our next entry to prevent this from happening again.

Still, it was a good set of answers that are worth reading, so let’s get to it. Here’s the list of investors included, in order:

Duncan Turner, SOSV

How many investments did you or your firm make in Q1, and how does that figure compare to Q4 2019 and Q1 2019?

We usually have a lower number of first checks in Q1 due to Chinese New Year; we are ahead this year so far versus 2019:

  • Q1 2019: 0 first check, 7 follow-on
  • Q4 2019: 13 first check, 19 follow-on
  • Q1 2020: 7 first check, 13 follow-on

How did your average check size change in Q1 when compared to Q4 2019 and Q1 2019?

It has not changed materially for us yet. We had a few rounds delay due to unknowns in the market. In these cases, we stepped in with previous investors to cover runway while new investors got comfortable.

Has your investment focus in terms of thesis/type of company backed changed in the last three months?

It has. We are a little more cautious on high-CapEx companies, which means we are focusing a little more on industrial IoT.

In uncertain times, we will look more favorably on companies that have stable contracts, particularly those that fit well into stimulus packages designed to boost the economy. We will continue to invest in companies providing digital health solutions with CPT codes for remote monitoring.

Do you anticipate it changing in Q2 2020?

The next four weeks will be critical; we will start to understand how the virus cases are flattening in the U.S. Hopefully, the economy can get through this very challenging period.

Are you as comfortable leading rounds as you were in 2019?

No change.

If not, are you not leading rounds at all, or simply less frequently?

As a fund, we are usually the first check into companies, we follow subsequent rounds; we typically don’t lead.

Have startup valuations among the cohort of companies you invest in changed materially over the last month?

Yes, we have seen valuations come down between 10-25%.

Do founders and investors have similar valuation expectations today?

I think most people understand that valuations are a reflection of the market. While there is uncertainty, good founders will know that it is prudent to lower the valuation targets.

Outside of normal remote-work changes, has your venture workflow (diligence, check writing, etc.) been impacted in the last month?

We use the program in Shenzhen to get to know them before committing to follow-on rounds; it is our due diligence. Due to travel restrictions, we have had to adjust to remote R&D (i.e. teams used to come to Shenzhen to get our help with R&D, now they access our 35 staff members remotely).

The situation is not great, but Shenzhen is almost at full capacity now, and it provides teams with a chance to accelerate tech while in a lockdown in the U.S. and Europe.

How has LP sentiment changed since the start of the COVID-19 pandemic, say, in January? Are sentiment changes accelerating?

We are not currently fundraising, so cannot speak to LP sentiment there. However, we have had some very positive feedback from our LPs who see the work we are doing to invest in companies directly solving the needs in the healthcare system that will help us beat COVID-19.

Has the fundraising process for founders and companies changed, or been meaningfully impacted by COVID-19?

Companies immediately addressing COVID-19 have found the fundraising process moving much quicker. However, for most, not being able to meet investors face to face will cause delays.

What type of advice would you give to founders who are looking to fundraise or are in need of fundraising in the current environment?

Right now, there is a lot of uncertainty. It is highly likely that COVID-19 could be around for an extended period of time. Highlight the areas of the business where you can prove that you have stability. Pilot projects may be delayed, so don’t set expectations around those.

Look for new opportunities to keep business going with your novel technology. Clearly, work from home and remote patient care will have extra attention from investors. Approach your existing investors to discuss an inside round to extend through these times.

Alex Doll, TenEleven Ventures

How many investments did you or your firm make in Q1, and how does that figure compare to Q4 2019 and Q1 2019?

We made three investments in Q1 2020, versus three in Q4 2019 and two in Q1 2019. Q1 2020 was weighted towards early-stage and non-U.S. deals.

How did your average check size change in Q1 when compared to Q4 2019 and Q1 2019?

Not materially. However, this is a little hard to assess, given our small sample size and the different stage investments we made. Most of our Q1 activity was already in-flight pre-COVID-19 as well.

Has your investment focus in terms of thesis/type of company backed changed in the last three months? 

As always, we have been 100% cybersecurity-focused, looking for investments globally, usually in “hard tech” applications solving difficult cybersecurity challenges. Our investment theses include security for hybrid cloud infrastructure (including compliance and authorization in those systems) as well as technologies enabling security in a landscape of a disappearing perimeter and ever-increasing numbers of endpoints.

For the last three months, we were already leaning into early and seed-stage deals and away from the growth stage, where our belief has been that valuations have been very high for the past couple years. We met many compelling early-stage entrepreneurs in the past three months.

Do you anticipate it changing in Q2 2020?

Yes. We think of it as a barbell of opportunity, really — more opportunity at the very later stages (growth, E, D) and the very early stages (seed, development stage, pre-go-to-market). More realistic valuations at the growth stage will become the norm, which makes things more interesting for us there.

We will continue with diligence on early and seed-stage opportunities, especially for companies in the development stage that need another 12-18 months before going to market. We will likely do less of the later and larger Series A, B and C rounds.

Thematically, while we have focused on cloud security opportunities and how they relate to distributed workforces for some time, the current crisis and the 100% remote work mandate have sharpened the world’s attention to this area.

Also, as phishing attacks on remote workers increase, we see opportunities in security awareness training for a distributed workforce. Two companies in our portfolio address these issues directly — Axis Security and KnowBe4.

Alternatively, we see potential deceleration in the areas of data privacy compliance as regulatory exemptions arise in response to the COVID-19 crisis. We will keep looking at this area, as we have a great deal of personal passion for it.

Still, more clarity is necessary on the exact regulatory impact this situation will have on buyer urgency. For now, it feels like business resilience mandates will take precedence over data privacy compliance issues.

Are you as comfortable leading rounds as you were in 2019? If not, are you not leading rounds at all, or simply less frequently?

Yes. We remain very focused on leading rounds.

Have startup valuations among the cohort of companies you invest in changed materially over the last month?

Yes, we have seen valuations change. Though seed and A rounds are about the use of proceeds to hit a Series B milestone and percentage ownership, so the early-stage rounds terms and valuations won’t be as volatile for any company.

We do think as VCs reevaluate reserves for existing portfolio companies, the number of new deals that get done in the early stage will decrease. That said, seed and A rounds are the furthest from the public markets, versus growth and Series E and D rounds (more closely tied to public comps), so there may be less pressure there.

Do founders and investors have similar valuation expectations today?

Founders aren’t immune to capital market dynamics, and they understand the situation. To be successful, founders should show a thoughtful use of cash and how these proceeds will help grow the business given current conditions. Be open and honest with how the market has changed and what is needed now.

Outside of normal remote-work changes, has your venture workflow (diligence, check writing, etc.) been impacted in the last month?

From a deal point of view, we are still beginning conversations with new prospective investments and doing diligence on deals in process, even though that is taking place over Zoom meetings now. We’ve often taken first meetings by phone or Zoom, so not too much change there. That said, I think it will be hard to get brand-new deals over the finish line without meeting founders in person or meeting their employees.

When it comes to existing portfolio companies and our advisory board members, there has been more time to have strategic and thoughtful conversations. So, it’s been an excellent time to get to know the people who you already know a bit better and explore new areas, albeit via video calls.

We have had a lot of recent discussions on the opportunity at this moment for leadership. The need and how to talk to employees, partners and customers about the current situation in an empathetic and partnering way.

There is also a chance to help the portfolio companies learn from one another, as they frequently have different strengths and come up with unique creative ideas. CEOs are interested in learning the patterns we see across the portfolio of like companies — are prospect meetings still getting booked, what digital marketing channels are most effective and what is the right tone and cadence of messaging?

How has LP sentiment changed since the start of the COVID-19 pandemic, say, in January? Are sentiment changes accelerating?

We may be unique from some other funds in that many of our LPs selected us for the sector-specific exposure we provide and the belief in the relative resiliency of the security sector. Many sophisticated LPs are searching for non-correlation with broader technology and public market indexes that private cybersecurity provides.

In addition to normal updates on specific portfolio companies and fund-level absolute forecasts, I think a lot of our LPs are validating their original fund thesis and the relative positive sector dynamics.

Has the fundraising process for founders and companies changed, or been meaningfully impacted by COVID-19?

Yes, there has been an impact. For companies who are just beginning their fundraising process, introductory meetings are still possible via phone and video calls.

However, it will likely be harder to get new deals over the finish line quickly. Timing will slow by the inability to meet face-to-face, plus VCs may need extra time with their existing portfolio.

What type of advice would you give to founders who are looking to fundraise or are in need of fundraising in the current environment?

First, if you can avoid fundraising right now, I would not do it. Even if you’re successful, it will likely be on more investor-friendly terms than last month.

If your business necessitates a capital raise now and you have existing investors, I would recommend having those investors introduce new investors. When you meet with new investors, be open and thoughtful with your revised projections. Don’t pretend nothing has changed.

For many businesses it may be that the long-term strategy and investment thesis is largely intact, but the near-term path may be slower. It is essential to assess what will be needed in this new environment and share that analysis with the investors for their feedback and thoughts.

Look for data points you can share with them that show the impact and explain how you will continue to build your company in this period. If you are approaching a new investor, it is more important than ever to explain to that investor why you are contacting that firm — what is the value add beyond capital that the partnership can bring to your company, and how will it help you succeed.

Alex Niehenke, Scale Venture Partners

How many investments did you or your firm make in Q1, and how does that figure compare to Q4 2019 and Q1 2019?

Scale averages six to 10 investments per year. We did not see an impact to our pacing in the first quarter. To be fair, the timing of COVID-19-related events was so late in the quarter that any impact to pacing would not reflect until the second or third quarter of the year.

How did your average check size change in Q1 when compared to Q4 2019 and Q1 2019?

Scale has not seen a material change in check size or strategy.

Has your investment focus in terms of thesis/type of company backed changed in the last three months?

No, Scale has always had an investment thesis around B2B technology and enterprise SasS; that focus continues. While we expect certain verticals to be hit harder than others, our interest in megatrends around intelligent software, automation and connectivity is still broadly applicable. We continue to look for future great companies to invest in.

Do you anticipate it changing in Q2 2020?

No.

Are you as comfortable leading rounds as you were in 2019?

We lead 80%+ of the rounds we invest in and do not expect that to change in the post-COVID-19 world.

Have startup valuations among the cohort of companies you invest in changed materially over the last month?

We have not seen enough volume to objectively answer this question. The truth is, most founders have hunkered down in the recent weeks, focused on managing cash burn and extending their runway.

Founders in the market and raising are aware valuations are coming down and seem willing to engage in conversations despite lower valuation expectations. We have also seen deals carrying pre-COVID-19 valuation ranges.

We will see how this evolves, and the truth is, even in downturns, great companies can still command strong valuations.

Do founders and investors have similar valuation expectations today?

We have been impressed by the alignment and solidarity throughout the startup ecosystem. We have seen neither founder nor investor tension. If anything, the environment has become more collaborative.

Outside of normal remote-work changes, has your venture workflow (diligence, check writing, etc.) been impacted in the last month?

Not materially. Like many companies, we adopted cloud-based, remote-friendly operations several years ago and all current workflows continue as normal.

How has LP sentiment changed since the start of the COVID-19 pandemic, say, in January? Are sentiment changes accelerating?

LPs, like many of us, are gathering information and re-running their analyses and risk profiles. LPs value transparency and communication, and we have been proactive in providing them updates about how we’re adjusting operations and guiding our portfolio companies.

We think that some LPs will be impacted by a denominator effect as their public holdings have sharply dropped. Simultaneously, many of our crucial relationships have reiterated a commitment to the stability and long-term prospects of venture capital, as well as a desire to continue to maintain time diversification across their portfolio going forward.

Paul Murphy, Northzone 

Has your investment focus in terms of thesis/type of company backed changed in the last three months?

Our largest fund to date — Northzone IX — was raised with the expectation that there would be a downturn at some point during the fund’s initial deployment period. So, we already set expectations with our LPs and the founders we’re tracking that we want time diversity in this fund and therefore we weren’t in a rush to deploy the fund, even pre-crisis.

We focus on the founders and the ideas with the potential to transform entire sectors, which is now more relevant than ever. We took the past few weeks to prioritize the health of our existing portfolio companies, but are now looking at new investments again — particularly in established industries, where legacy technology comes under pressure in a global crisis.

Regardless of the sector, strong founders with genuine innovation at a product level have always been significant for us and that will not change even in the current circumstances.

Do you anticipate it changing in Q2 2020?

The crisis is going to play out over years, not quarters, so any impact to the market will unfortunately be somewhat long-lasting from our point of view. That said, our best investments took place during downturns, so we’re as focused on finding new investments as ever.

This is still an early stage, but we are already seeing the crisis clearly accelerating some trends that were already in play, as the necessity of working with distributed teams and new ways to enable remote working effectively.

Are you as comfortable leading rounds as you were in 2019?

Yes. VC funding will slow down in 2020 relative to 2019 and I think there will be fewer FOMO rounds because investors will take more time to get to know and diligence the business.

I don’t think that’s necessarily a bad thing. It might also take a bit more time to close deals; however, we will continue to lead rounds and back great founders.

Northzone has been around for 24 years, so we’ve seen our fair share of industry-shaking events as investors and as founders and operators ourselves. We’ve learnt that the show must, and will, go on despite these uncertain times. Some of the most transformative businesses of recent decades were founded and scaled during times of uncertainty.

Outside of normal remote-work changes, has your venture workflow (diligence, check writing, etc.) been impacted in the last month?

Northzone is already a distributed team that operates across multiple geographies and time zones, so we’re accustomed to getting deals done remotely. Generally speaking, we are able to carry out all of our processes as normal and can make an investment without meeting a founder face to face.

Has the fundraising process for founders and companies changed, or been meaningfully impacted by COVID-19?

The best companies will continue to get funded so that will not change. However, the recent breakneck speed of VC is likely to slow down as investors take extra time to get to know the founders and the product they are building.

What type of advice would you give to founders who are looking to fundraise or are in need of fundraising in the current environment?

What differentiates COVID-19 from past economic downturns is the uncertainty over the scale of it; however, it’s already creating new realities. The right strategy for most startups is to not underestimate what’s going on or assume that it will be business as usual after the peak of the crisis. Even the best companies must take proactive measures to manage burn and assume that it could take six to eight quarters before a competitive funding climate re-emerges.

Adapting quickly will be key, from building new cost-base assumptions, revising acquisition costs or taking a long and hard look at the product/market fit. Having seen our fair share of industry-shaking events at Northzone, we know the most fruitful investments can be borne out in times of crisis, but it’s not easy.

Sean Park, Anthemis

How many investments did you or your firm make in Q1, and how does that figure compare to Q4 2019 and Q1 2019?

  • Q1 2019: 10
  • Q4 2019: 12
  • Q1 2020: 9

How did your average check size change in Q1 when compared to Q4 2019 and Q1 2019?

No change.

Has your investment focus in terms of thesis/type of company backed changed in the last three months? Do you anticipate it changing in Q2 2020?

No. Looking ahead, it will adapt at a micro-level (company-by-company) to align with the expected post-virus landscape. Some areas of financial services will become more attractive investment opportunities, some will remain the same and others will become less so on a one to three year horizon.

Are you as comfortable leading rounds as you were in 2019? If not, are you not leading rounds at all, or simply less frequently?

Yes. As thesis-driven investors, we historically lean into leading investment rounds across our portfolio. As a result of the pandemic, we will likely become marginally more open to co-leading or syndicating at least in the near term (next six months).

Have startup valuations among the cohort of companies you invest in changed materially over the last month? Do founders and investors have similar valuation expectations today? 

Super-heterogenous generalizations are not very useful. This depends on the company, stage, impact of market prospects, etc. In my opinion, it’s still too early to make robust determinations.

Outside of normal remote-work changes, has your venture workflow (diligence, check writing, etc.) been impacted in the last month?

Not really. The process is perhaps a bit slower and we’re able to be more deliberate due to less competition. We’ve found that “FOMO” investors have disappeared, which is healthy.

How has LP sentiment changed since the start of the COVID-19 pandemic, say, in January? Are sentiment changes accelerating?

The changes we’re seeing are not huge. Most LPs are being very thoughtful and perhaps more deliberate. Good LPs understand that early-stage venture returns depend on what the world will look like in three to 10 years, not three to 10 months. One must also be conscious that the best venture vintages historically have been during or immediately post-market dislocations.

Has the fundraising process for founders and companies changed, or been meaningfully impacted by COVID-19?

From a VC perspective, there is more focus on existing companies and those in the pipeline for now — say the next one to four months. There is also increased attention on underlying (prospective) unit economics, business model fundamentals and runway versus growth for growth’s sake.

What type of advice would you give to founders looking to fundraise or in need of fundraising in the current environment?

Lean on your existing investors to the extent possible. Have a very clear, robust (and lucid) view of unit economics — no more “build it and figure it out later.”

Be conservative with spend and runway projections — apply more focus on product near-term, less on marketing and growth. Things still might be early and speculative, but try to present how COVID-19 affects or will affect your business now (next 12 months), in the short term (next 12 to 36 months) and over the long term (in a post-virus world).

John Vrionis, Unusual Ventures

How many investments did you or your firm make in Q1, and how does that figure compare to Q4 2019 and Q1 2019?

I’d rather not share specifics, but happy to report that our Q1 2020 was very similar to Q4 2019 and Q1 2019.

How did your average check size change in Q1 when compared to Q4 2019 and Q1 2019?

Again, very similar. No change.

Has your investment focus in terms of thesis/type of company backed changed in the last three months?

No.

Do you anticipate it changing in Q2 2020?

Not meaningfully.

Are you as comfortable leading rounds as you were in 2019?

Yes.

If not, are you not leading rounds at all, or simply less frequently?

We are an early-stage focused firm. The external environment has very little impact on our strategy. We expect to lead (95% of the time) as we did in 2019 in terms of investments, if not more, in 2020.

Have startup valuations among the cohort of companies you invest in changed materially over the last month?

I don’t have enough data to say definitively, but I suspect yes. Savvy founders are taking money if they can, even if it means opening prior rounds. The cost of capital has gone up.

Do founders and investors have similar valuation expectations today?

At the seed and Series A stage, I believe so, yes.

Outside of normal remote-work changes, has your venture workflow (diligence, check writing, etc.) been impacted in the last month?

Yes, meeting entrepreneurs in person has always been “standard” as part of the investment process. That’s not happening right now for good reason.

The lack of in-person meetings makes it harder to build a sense of trust — both ways (for founders and for investors). The net effect of this is that investment decisions slow down.

How has LP sentiment changed since the start of the COVID-19 pandemic, say, in January? Are sentiment changes accelerating?

We are grateful to have LPs who are experienced enough to know it makes sense to keep investing even in volatile market conditions.

Has the fundraising process for founders and companies changed, or been meaningfully impacted by COVID-19?

Yes, the process has been meaningfully impacted. Investors would prefer to meet founders in person before committing to a long-term relationship.

Investors have been trained to operate this way and the inability to meet with founders live is a divergence from that ingrained “habit.” Virtual meetings still work of course, but I think it would be wrong to think that there isn’t a negative impact on the fundraising process.

What type of advice would you give to founders who are looking to fundraise or are in need of fundraising in the current environment?

Have more patience. Be more flexible. Work with your current investors and understand the new market realities for new investors.

Uncertainty in future market conditions creates additional risk for you and for investors. Recognize capital is now more expensive. Understand what kind of business you are building and do what is best for the long term for your company, employees and investors.

Shortsighted founders will make poor decisions during these uncertain times and will likely not have companies that survive to see the market comeback. The resilient, adaptable founders and investors will emerge stronger.

Plus any other thoughts you want to share with TechCrunch readers.

Market volatility separates the great from the good and the mediocre when it comes to founders, investors and companies. Building a startup is hard — it’s like driving on a road under construction.

Resilience matters. Don’t shy away from the difficult decisions. Tackle them head on and do what you have to in order to survive.