The pendulum will swing away from founder-friendly venture raises

@alex / 6:54 am PDT • April 3, 2020

Image Credits: Janko Ferlič / Unsplash (Image has been modified)

Hello and welcome back to our regular morning look at private companies, public markets and the gray space in between.

This morning brought fresh economic bad news for the U.S. economy, with over 700,000 jobs lost in the latest report, despite the window of time measured not including some of March’s worst days, and the data itself not counting as many individuals as it might have; the unemployment rate still rose nearly a full point to 4.4%. The barometer generally expected to rise far higher in a month’s time.

Rising unemployment, markets in bear territory, shocking weekly unemployment claims, and some major states just starting lockdowns paint the picture of protracted downturn that has swamped our national and state-led economic response. Some help is coming, but individual payments are probably too small and too late. And a key program aimed at helping small businesses is rife with operational mistakes that will at least delay rollout.

It’s an economic catastrophe, and one that won’t lead to anything like a V-shaped recovery, the vaunted shape that everyone holding equities through the crisis was hoping for. We’re entering a prolonged slump. Precisely how bad isn’t yet known, yes, but it’s going to be bad, with unemployment staying elevated into 2021.

The impacts of the national economic slowdown are going to change the face of venture capital as we’ve come to know it during the last ten years. How so? Let’s talk about it.

After picking through some COVID-19-focused PitchBook data this morning, it’s clear that the era of founder-friendly venture terms is heading for a reset. Even more, recent economic and market data, TechCrunch research and select trends already in motion help paint a picture of a changed startup reality.

So this morning let’s talk about what is coming up for the world of upstart companies and risk embracing capital.

It’s not just valuations

TechCrunch recently spoke with a half-dozen venture capitalists, asking after how their world has changed and how they are approaching dealmaking in the new reality. One common note was that startup valuations are declining. This makes sense; as growth concerns rise, future expected cash flows decline, harming present-day valuations of companies. This is something that Bessemer growth investor Mary D’Onofrio walked us through earlier in the week.

But past valuation adjustments, there’s going to be more change. Here are some stats that no longer make sense in our new, awful economic reality:

According to PitchBook, only 9% of domestic venture rounds in 2019 were down-rounds. That’s going to change. PitchBook notes somewhat dryly that “down rounds are liable to climb” from recent lows. Yes, and sharply. It’s not hard to anticipate a host of companies eating a tough round so that they can survive the next few quarters. Those equity rounds are going to come at a high cost and at a lower sticker price.
Per PitchBook, only 14% of domestic VC deals in 2019 had “liquidation participation rights,” an investor-friendly mechanism that protects returns for capital sources at the expense of common shareholders during cheaper than anticipated exits. The 14% figure was a record low, beating 2018’s prior record low of 17.6%. After falling every year since at least 2019 (when it was over 50%!), expect this number to rise.

What else? There are a number of venture trends that we’ve been tracking that come to bear in the new reality, so let’s push them into the future with a smidgen of creative thinking:

We’re seeing a rise in B2C SaaS churn that is shocking; it’s far worse among consumer-facing businesses than B2B shops so far. The venture capital appetite for B2C startups is going to dip until consumer behavior begins to improve on a predictable basis. Sure, some B2C startups will excel in the downturn. However, with millions losing their jobs each month at home, it’s a pretty rough time to be asking for regular folks’ money. This will further ratchet the venture world in favor of B2B startups, a trend that was already afoot in 2019 and will accelerate in 2020.
The early 2020 declines we saw in mega-rounds will continue, as the recently risk-on world of late-stage venture capital pauses in the face of (even more limited) exits now that the IPO window is firmly shut. TechCrunch took a look at mega rounds, or financing events of $100 million or more, and found in middle-late March that Q1 results were already down compared to the year-ago period. Then the United States’ economy really fell off a cliff. Who wants to cut $100 million loose into a startup with the exit market looking anemic? We’ll find out, but it will be fewer investors at lower dollar amounts and slimmer valuations.
IPOs are dead. After the Casper debut (bad) and One Medical (pretty good) IPOs in early Q1, two more venture-backed companies filed to go public domestically in late February: Accolade (more here), and ProCore (our coverage here). Neither has since filed an S-1/A to report more recent financial results. And there have been zero new venture-backed filings of note since. That means the venture-backed IPO pipeline was zero even before the economic damage of COVID-19 really got rolling here at home. The pain is only going to get worse, so it’s pretty easy to expect a de minimis IPO crop for the foreseeable future. There could be some breakouts — Asana could get out since it’s probably seeing demand skyrocket, and maybe a handful of others — but the 2020 Airbnb direct listing is probably now a 2021 Airbnb IPO at a lower valuation at best. You get the picture.

So we’ve seen a flight to B2B startups, we’re hearing about a decline in private valuations, and we’re expecting an end to the momentum pushing VC terms more friendly while also seeing fewer huge rounds and the exit market going full M&A. Ew.

The pendulum will swing away from founder-friendly venture raises

It’s not just valuations

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