For the vast majority of startup founders who were planning their capital raise in Q1 2020, the COVID-19 blow was so dramatic and sweeping, we cannot see all its effects at once.
One big question on the minds of most founders: How should we plan our next raise in terms of timing, valuation and amounts?
Sarah Guo, partner at Greylock Partners, says the fundraising environment has slowed down significantly, but founders who have built ties with VCs via informal coffee updates and check-ins are at a clear advantage. “Early-stage bets require relationship-building,” says Guo, who has been investing in seed through Series B rounds.
Ram Shanmugam, founder and CEO of AutonomIQ*, a seed-stage code and process automation company, has been strengthening his relationships. For a company that has low operating expenses and a community of 600,000 developers, he says he is not fazed. “Our automation code brings efficiencies and in fact, we have nine inbound leads in Q2. Having said that, we are being realistic at the pace at which we can close these contracts.”
Similarly, Fred Blumer, who exited Hughes Telematics at an enviable $750 million, says he is taking a more pragmatic approach to the Series A raise for his new company, Mile Auto. “We expect to have a 5x growth in our business in 2020, even after adjusting for COVID,” he said. “Our pay-per-mile insurance is a great fit for people who are driving less.” Because so many drivers are sheltering in place, legacy insurance companies are refunding hundreds of millions of dollars to customers, which offers an advantage (and an opportunity) to a startup like his.
“But we need to be patient and mindful. While our families, health and safety are top priority, we are staying focused on our customers,” Blumer said. “Insurtech is a resilient arena, and in my past company we raised $100 million, so working with investors has never been a challenge. Keeping up with growth and perfecting the customer experience are what keep us up at night.” He said he plans to get out in the market after investor confidence returns.
Which may be a good idea, considering Jason Lemkin’s Twitter survey, where only 32% of respondents said they plan to deploy the same amount of capital as in the past. But another 30% are on the opposite end of the spectrum, deploying 40% to 60% less capital.
Lightspeed Partners (LSVP) recently announced a new fund with $4 billion of fresh capital.
“In this new environment, we will certainly continue to invest in ambitious, outlier founders tackling large problems with disruptive products and technologies,” says Arif Janmohamed, an LSVP partner for over a decade. “That said, our decision-making velocity has become more deliberate as we invest more time with founders to understand their long-term vision, their commitment to build enduring businesses and to dig into how they are planning to build their company in this different environment.”
Similarly, Cack Wilhelm, a partner at $1.5 billion growth-stage fund IVP, says “time from first meeting to term sheet has slowed down. Companies are in the midst of reforecasting and adjusting their projections, and we are being deliberate about new opportunities.”
Investors are also focusing more on adaptability and resilience. “In the COVID-19 market conditions, founder’s traits such as leadership, adaptability and decisiveness are more pronounced than ever before,” says Oren Yunger, partner at GGV Capital, which continues to deploy at the same pace and does not anticipate much changes. Jordan Cooper, partner at Pace Capital, has just raised a $150 million fund and does not have the baggage of an existing portfolio to worry about, a sentiment he expressed with a tweet: “I don’t need 3- 6 months for the dust to settle. Am ready to lead your Series A right now.”
“New firms like Pace who don’t have 50 companies to support will be very active through this period. It’s going to take a while for the folks who already sit on 16 boards to pick their heads up and proactively invest in the new normal,” he says.
One key takeaway from these conversations is that investors with fresh capital could move faster, especially at seed and early stages. Earlier-stage companies have longer cycles to exit. But what about valuations? Can we expect the kind of love that Masayoshi Son of SoftBank fame showed to his founders? Not anymore.
Gopi Rangan, general partner at seed-stage insurtech-focused fund Sure Ventures, says “entrepreneurs still live in the euphoric pre-COVID times and are not ready to accept longer sales cycles. Being optimistic is good, but having a dose of pragmatism helps. I am tired of asking basic questions.” Guo of Greylock echoes similar sentiments, noting, “we were overdue for a valuation correction pre-COVID, and I believe it will take multiple years to return to 2019 valuations.”
Cooper shared a succinct view of the valuation trend: “The best proxy I have in the absence of hard data is how founders are adjusting round sizes. If you assume they are still budgeting similar dilution at the Series A round, say 20%, for a smaller raise of say $5 million instead of $8 million, that would suggest implied valuations is reduced by 30-40%. It’s unclear how many of those rounds are actually clearing, but that’s where the discovery price seems to land.”
For later-stage investors, the public markets proxy are a reasonable starting point, said Jack Young, partner and head of venture capital at DTCP, a $350 million fund focused on expansion and growth-stage companies. “Valuation is a function of performance, as well as public market multiples. Cloud software multiples are trading around ~8x median EV/forward revenue but high-growth companies are double and outliers like Okta are Datadog much higher,” he said.
Wilhem reminds us that VCs are simultaneously buyers and sellers: “Exit windows are closed, and will be for some time.” Gaurav Bhasin, managing director at boutique technology M&A firm Allied Advisers, noted that deals are taking longer to close.
“Transaction times and efforts have increased,” he said. “It’s 2x longer and 2x harder to finish a transaction; lack of face-to-face interaction is typical in deals. These create challenges which are somewhat alleviated by collaboration tools. But the markets will open up gradually and quickly for technology sectors. Cash holdings of top S&P 500 Information Technology firms totaled $504.9B as of 31st March 2020. Among PE firms, reserves of dry powder is estimated to be around $1.5T are at record levels,” he pointed out in a recent post.
Image Credits: Allied Advisers
When public markets and exit windows slow down, later-stage investors exhibit more caution as their investment cycles are shorter compared to seed and early-stage investors. Yet the universal message was that for great companies, where teams are strong and performance is stellar, valuation is seldom an issue.
Sectors such as government and healthcare that were lagging in adoption of modern technologies were forced to make changes overnight as COVID-19 cured them of technology adoption inertia. The importance of cybersecurity became paramount — endpoint security, telehealth and distance learning just got a swift kick in the pants, as did communications. Gartner predicts that global 2020 IT spend post COVID-19 will drop by at least 5%, which translates to $196 billion. Cooper says that value is rapidly flowing out of deeply entrenched incumbents. With ~40% headcount reductions, there is no longer a switching cost to adopt automation.
Founders who have moved to an inside-sales model adjusted 2020 realistic projections (flat to a modest 20% growth from 2019) and reduced opex will certainly benefit from such moves. Buyers have slowed down their purchasing processes substantially. About 30% of the workforce is struggling unable to fulfill basic needs, and cash is king. Pretending that these macro events will not affect your startup is a clear sign of naïveté, or even narcissism.
While founders adapt, VCs have been forced to shift away from the old “touch-feel the CEO” investment processes. VCs are trying to come to terms with one fundamental challenge — should they close on a new investment without a face-to-face meeting with the management team?
Jack Young at DTCP has updated his social media profile picture with a #WFH. Like most firms, Greylock too is trying to figure out how to get comfortable with teams they have never met in person. While this shift can remove some subjective bias and lead to better data-driven decisions, early-stage companies do not have much data to share.
“It took about a year for the early-stage markets to open up after the 2008 crisis,” says Jordan. Will we see a similar pattern? The election cycles are upon us and politicians may use the crisis to further their advantage, often at the cost of delaying or creating economic trade-offs.
But the billion-dollar question is, what behaviors will sustain, and what reverts back to the mean?
“Crises are clarifying,” says Guo. “All effort is put toward first-order issues when companies don’t have the resources or time to spend on the second-order issues” In short, we start focusing on what matters most.
- Disclosure: I am an investor in AutonomIQ.
