A month ago, we asked several venture capitalists if they planned to change the way they invest or lead rounds during COVID-19 — most said no, but they noted that valuations were coming down and founders in their portfolio companies were responding to the crisis.
Northzone’s Paul Murphy predicted fewer FOMO rounds because investors will “take more time to get to know and diligence the business… and it might also take a bit more time to close deals,” adding that he would “continue to lead rounds and back great founders.” But, as other investors call their bluffs, firms are looking for tangible ways to show they are open for business.
First Round Capital
At least that was the case with First Round Capital. On Thursday, the seed-stage firm announced that when it leads a first round in a company, it will always take pro rata in the next outside-led venture round with a commitment of up to $3 million.
Pro rata is a clause in an investment agreement that gives the investor a right to participate in future financings. If investors don’t invest in a company’s pro rata, that might negatively signal they don’t believe in the company’s future. I asked Brett Berson, a partner at First Round, to offer more context about the announcement.
“The question ‘is your investor taking their pro rata’ is not necessarily a checkbox answer,” Berson said. “And I think in a time of maximum uncertainty, what a given investor was doing 12 months ago might not be what he or she is doing today.”
In an upmarket, there’s “euphoria and most people are taking pro rata,” he said. Now, as markets oddly tip back and forth, the future becomes more confusing.
First Round, said Berson, has long invested in the pro rata of its portfolio companies internally. The public announcement was the firm’s way of being “clear about our overall stance, and ideally other investors will follow.” A less public anecdote, Berson said, is that First Round Capital has seen more investor collaboration through passing deals. “It’s becoming more proactive.”
Accelerators
Last month, Y Combinator changed its policy on automatic pro-rata investments and will now invest on a case-by-case basis. 500 Startups has not changed its case-by-case thesis either, the accelerator confirmed.
Beyond pro rata, some VCs are launching programs to keep their eye on trends (and potential deal flow).
NextView VC, which closed a $75 million fund in January, launched an accelerator for the first time ever. It will invest $200,000 for an 8% stake in fewer than 10 startups. “During this current COVID crisis, we have seen many VCs publicly saying that they are ‘open for business,’ but we wanted to put our money where our mouth is,” partner David Beisel told TechCrunch.
Cleo Capital, founded by Sarah Kunst, is launching a fellowship for laid-off workers, free of charge. It is not taking any equity, but Kunst noted that she hopes any startups that are born as a result of a fellowship will give Cleo the chance to invest.
Signaling
Signaling happens when a VC chooses to not do follow-on investing in an existing portfolio company. If someone who knows you well isn’t willing to invest in you in your next phase of growth, it “signals” to the venture market that the deal might not be worth your time. And boom, negative perception means others get cold feet and then your Series A or B falls apart.
Signaling has always been a wary problem for early-stage founders. These initiatives are an attempt at removing some of that signaling.
For example, NextView, alongside its accelerator announcement, was upfront in saying it will not lead follow-on investment for its future cohort. Same story, different approach with First Round’s choice to lead a minimum investment in future pro rata, across all (not some) investments. Now future investors will not judge cohort companies by a lack of investment and won’t be able to separate which First Round startups got pro rata and didn’t. Both firms are trying to avoid negative signaling by oversharing.
What would have been a marketing play a few months ago is now more noteworthy to us because it is a tangible way to understand how venture capitalists are spending money these days. It’s important to see firms being transparent and consistent in the way they invest. Clarity, amidst a pandemic, is always good news.
