A generation of companies now needs to forget what it has learned. The world has changed for everyone, and nowhere is this more true than in fundraising.
I’ve been investing in technology companies for over twenty years, and I’ve seen how venture capitalists respond in bull and bear markets. I’ve supported companies through the downturns that followed the dot-com bubble and the global financial crisis, and witnessed how founders adapt to the new environment. This current pandemic is no different.
A growth company that only a few months ago was shopping for a $20 million, $30 million, or even $40 million Series B, with a choice of potential investors, must now acknowledge that the shelves may well have emptied.
VCs who were assessing potential new deals at the beginning of the year have had to abruptly adjust their focus: Q1 venture activity in Europe was under its 2019 average, and the figures for the coming months are likely to be much worse as the pipeline empties of deals that were already in progress.
The simple reason for this is that VCs are having to rapidly reallocate their two principal assets: time and capital. More time has to be spent stitching together deals for portfolio companies in need of fresh funding, with little support from outside money. As a result, funds will be putting more capital behind their existing companies, reducing the pool for new investments.
Added to those factors is uncertainty about pricing. VCs take their lead on valuation from the public markets, which have plummeted in tech, as elsewhere. The SEG index of listed SaaS stocks was down 26% year-to-date as of late March. With more pain likely ahead, few investors are going to commit to valuations that founders will accept until there is more certainty that the worst is behind us. A gap will open between newly cautious investors and founders unwilling to bear haircuts up to 50%, dramatic increases in dilution and even the prospect of down rounds. It will likely take quarters — not weeks — for that gulf to be bridged and for many deals to become possible again.
Even in an optimistic scenario, Q2 will largely be a write-off for major new deals and the remainder of the year may only see a gradual recovery. We are probably looking to 2021 before the funding market begins to resemble what it did a few months ago.
In other words, the market for significant new deals is about to become weaker than at any point since the financial crisis of 2008-2009. A generation of companies that has grown up in a benign environment for fundraising now needs to forget what it has learned. There is still a path to growth and success, but it already looks very different from the one that most had plotted.
This is undeniably a challenging time for our community. But as someone who has weathered past downturns, having invested and managed companies through the 2009 and 2001 crises, I know that there is a light at the end of this tunnel.
For companies that find themselves having to reassess their Series B plans, I would offer these pieces of advice.
- Adjust your expectations. The round you were planning to raise isn’t dead, but it is certainly delayed, and possibly by longer than you think. Be conservative in your assumptions, and don’t rely on raising a large round at a favorable valuation for at least 12-18 months. Make sure your business model can hold up if 18 months turns into 36. We still don’t know how long a shadow the pandemic will cast. Founders and VCs are optimists by nature, but we must all accept that this could be a bigger and longer problem than anyone currently wants to admit.
- Slow your burn. Waiting longer for your next major fundraising means making your cash last for as long as possible, while keeping strong momentum running within the business. You need to be ruthlessly selective about making targeted investments in product, marketing and sales, while moderating your burn rate as much as possible. With new funding in short supply, no company can afford to run out of money.
- Think smaller. Big rounds may be on lockdown, but that doesn’t mean all routes to accessing capital have been closed off. If fundraising becomes a necessity, look to your existing investors and local or niche funds who may be willing to write smaller checks. If looking outside of your existing investors, prioritise funds with whom you’ve already established a relationship and/or who are close to you by means of geographical distance, mutual connections, or area of focus or expertise. Venture debt is another option to consider for companies that have previously raised equity finance, especially if you lack the cashflow for traditional debt finance.
- Be nimble and flexible. If you need to raise money in order to maintain momentum, but have accepted that you need to do so by raising a smaller intermediate round before going after the big money, try to bridge the likely valuation gap between company and investors by balancing risk/reward, or you risk getting stuck in endless discussions. Perhaps accept only a small increase on your last round valuation in exchange for the investor(s) doing part of the funding at that valuation and part as a convertible into the next round – even with some discount. Or you could accept only a moderate increase on your last round valuation in exchange for the investor doing a smaller amount (which will therefore be less dilutive) with the remainder raised as venture debt. There are infinite variations here, but the key takeaway is that if you want to quickly secure some additional capital to continue pushing the gas, you need to show some flexibility and make sure there is an upside for the investor in moving quickly.
- Plan ahead. If you are going to raise a big round down the road, set yourself up for success by adding investors in the interim who can be helpful in raising the next round by increasing the strength of the insider-consortia (which will increase your bargaining power with new investors) and by opening up warm introductions to relevant investors.
The next few quarters will be the most challenging time that many founders have experienced. More so than ever, survival is not a given. Our advice as a firm is to remain focused — in the short-term, on making your company as robust as possible, and in the medium-term, on raising the next large round that will reset your course toward category leadership. Don’t lose sight of your destination; just accept that the route has become a little longer.