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Pandemic forces fundraising founders to accept ‘discounts across the board’

‘We’re looking at a 15% to 25% discount to do deals’

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Startup founders who are fundraising in this climate should expect venture investors to take a huge chunk out of their valuation expectations.

“What we’re seeing across the board is discounts,” says Mike Janke, co-founder of early-stage cybersecurity investment firm Datatribe.

Investors are still committing to new deals, he says, but they’re adding new terms and demanding lower valuations from companies as the cost of raising capital during the downturn. Janke, whose firm has several deals in the pipeline, says entrepreneurs should expect VCs to demand concessions like more frequent board meetings and large price cuts compared to what they’d previously seen.

“If you look at 2000 and 2008, venture always views [downturns] as the time to get good deals,” Janke says. “We’re looking at a 15% to 25% discount to do deals.”

In one instance, a company that turned down a $900 million acquisition offer is now in the process of raising a new round at a $500 million valuation, he says. “In 2019 it was just generally accepted that this company was worth over $1 billion.”

Deals are getting done, though. As the pandemic began to spread, Janke says most firms began triaging their portfolios to determine who would need to raise cash and who could remain afloat without an infusion. Now, firms are looking out and seeing what kind of opportunities there are in the broader market — if they can.

“Some of our peers in the Valley have up to 40% of their companies that need an infusion or some sort of bridge to get through,” says Janke. “These companies that had higher valuations that came out of the Valley have had to do more drastic cuts.” Startups that raised cash in markets outside the Bay Area have not had as much difficulty, he says, because they’re more efficient.

“When you see regions like Boston, the DC corridor, Austin and Boulder, those companies don’t raise as big a round and they’re a little more financially conservative.”

Even more disheartening than valuation reductions are the deals that will never close. Multiple investors have said they’ve seen new lead investors walk away from the negotiating table or pull term sheets in the new environment. Acquisition deals have also been scuttled or faced last-minute renegotiations around pricing, these investors said.

“Receiving a term sheet doesn’t carry the same weight as before,” said one investor. “There is risk when you get term sheets and the same when you get an LOI to sell your company.” With certain acquirers, if their market capitalization changes or they know they’re the only bidder, entrepreneurs can expect a holdup at the close of negotiations to get better terms.

One investor at a large multi-billion dollar firm said much of the new valuation reality depends on the stage of the company and its sector. Online gaming, online education and remote productivity seem to be more insulated, but certain consumer product companies, such as advertising-related businesses or parts of fintech, are likely to see a hit.

“A month ago you were selling for x — now, if you get the offer, you’re selling for 50% to 70% of x,” the investor said.

Then there’s the split between early- and late-stage deals. The former are more protected from vagaries of the market, but later-stage companies face a lot of headwinds thanks in part to the public companies that provide their comparables.

Since the public stock market plummeted, expectations for later-stage private companies have been reset because assumptions about their valuations were no longer valid. The same is true for their actual revenue assumptions, which must to be taken into account, the investor said. “Your existing economics are much worse. Your runway is much worse.”

Still, most investors say there are alternatives to simply walking away from commitments or taking a significant haircut.

“In one instance, the other firm was very collaborative and they negotiated for a slightly lower valuation. Because it was the right thing to do for all partners… in another case another firm that signed a term sheet offered a good alternative… keep the valuation the same and we raise more money,” the investor said. “Increase the round size by 20% or 25%.. [That] meant more dilution for investors and founders… but it kept the post-money valuation the same and decreased the pre-money valuation to increase the round size.”

The point, the investor said, was that if an VC has done their research, they should be able to stand behind the deal.

“If you’ve done your diligence, you should be more collaborative,” the investor told TechCrunch. “The first thing you should do is increasing the round size and keep either the pre-money or the post money valuation the same and that would give you extra runway. If you pull the term sheet, then you have not done your diligence right.”

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