Investment Decisions In A Pandemic World
This is a post for startup founders to hopefully better understand how investors and VC firms are adjusting to this new world. There are lots of tweets floating around citing “business as usual” and “we are open for business” — and while those proclamations and others may be true, there is a lot going on behind the scenes that I believe founders should consider as they plot their capital planning for 2020. [At the risk of stating the obvious, during this time posts like this are not as critical as what we can be doing within our own cities and towns to help our neighbors and local businesses.] I wanted to share these thoughts briefly after spending the last three weeks talking to tons of VC colleagues, from seed to growth funds, across the Bay Area and in NYC. With that, here are the real-time adjustments underway in the investor world:
Adjusting to WFH, with Children: With California and New York City on government-mandated shelter-in-place, investors are all home. Assume most decision-makers have kids. Schools are shut down. Like everyone else, they are scrambling to figure out how to support their kids, families, spouses, and concentrate on work and key decisions. For most, it is not an easy adjustment.
Portfolio Triage: An investor’s portfolio will contain some companies that are either directly impacted by the pandemic, such as companies which focus on travel, events, and other gatherings, and many that will be indirectly impacted because of this double-sided supply and demand shock. Companies with short runways will die, and even more jarring, companies that operate in certain industries could fold because of a foundational collapse caused by these shocks. If an investor is on a board and/or representing his/her VC partnership in a company, they have to report back to the mothership on a quarterly basis, so many of them are likely preparing for collecting and sharing negative news, and scrambling for ways to help CEOs cut burn, reduce opex, consider bridge funding, venture debt, and so forth.
Partnership Meetings and Hallway Chats: The manner in which 99% of VC firms operate — “the partner meeting” — is now a big challenge. Zooms work for sharing information and aggregating that audience, but the hallway chats and interesting tangent threads are gone. It is certainly cool to complain about partner meetings on Twitter (I have done this!), but having sat in institutional VC partner meetings for over seven years now across three firms, they’re certainly not perfect but they’re a terrific way to learn and get the pulse of a group. An interesting note on fund models like Founders Fund, for instance, which doesn’t have a partner meeting, may be less impacted in this way. Other VC firms will have to adapt to this but it will take some trial and error given institutional behaviors.
In Process vs. Existing Exposure vs New Relationships: Deals that were “in-process” before the day the NBA cancelled the season (that was a seminal day, I think) are closing and getting done. Sure, some folks will retrade deals, but maybe that number will be very small. Most investors know that going back on your word, especially under a time of duress, will ruin reputations. So when you see VCs say they just signed a term sheet, consider that deal may have been on handshake in February. Investors will also look into their existing portfolio and may offer to allocate reserves to existing relationships. You can bet these offers will be at “flat” prices to the last round, given how high valuations have been. Now, the key question for founders is new relationships — what if you were hoping to raise your A or B in Q2 or Q3? How do you meet and greet for a $15M check via Zoom or FaceTime? How will a VC be able to conduct on-site due diligence when the actual site is closed? I am sure some folks will adjust here and make decisions, but we don’t know yet whether that’s a good or bad thing. This is why I feel existing relationships will increase in value — psychologically, it is much easier for a VC to gain conviction in writing a check when he/she already knows the CEO, some team members, and so forth.
Existing Relationships Will Become Even More Valuable: I’ve touched on this in the post, so will just briefly repeat it as a separate point here because I believe it’s important on its own.
Angels, Syndicates, and Micro-funds: Angel-investing will continue, but some angels and scouts may have had their entire net-worth reshuffled this month; syndicates, which raise funds per deal, may suffer given the constant coronation costs they require; and micro-funds and seed funds, actually, will continue to invest early — the supply/demand imbalance is still in the founder’s favor here, so I don’t expect as much of an impact on valuations here versus at the Series A/B stages. We will know more over the next 4-8 weeks.
New Fund Management Precautions: No matter small or large, those who manage a VC fund are thinking about how this may impact various angles of fund management. For example, should pacing slow down? If a fund was planning to raise in Q2 or Q3, should they reopen their current fund to increase their runway and push out their own fundraise? Do they need to rethink their current reserves strategy to make sure key portfolio companies have the cash to weather this storm? The list goes on and on. When these questions pop up, it can logjam decisions to send cash out the door. I don’t think this is a major issue, but like the in-person partner meetings, will take a few weeks to settle.
The Money Source Is Stressed: This is a part of the startup ecosystem 99% of founders never see or grok. Most of the large VC firms raise money from large pools of institutional capital — pensions, nonprofits, universities, and endowments. The stock market just cut off 30% of value in less than 10 days. For most of these places, VC is a small percentage of where they invest, and they will continue to invest. But, consider for a moment nonprofits, many who rely on donations and fundraisers to keep operations going — the demand shock and travel restrictions will hurt these places in the near-term. Or, consider large universities which have sent students home and/or have medical/science or hospital systems which are on the front-line now to help their local areas combat the pandemic. All of these limited partners will stay in venture, of course, but they’ll also rely on their managers — the VCs — to be stewards of their capital as this downturn begins.
Weekly Information Likely To Worsen, Valuations and Economy To Follow: If founders take one thing from this post, I hope it’s this — While VCs are open for business, the overwhelming majority of folks I’ve talked to (nearly 75 by phone over last two weeks) are by no means stopping the pitch meetings, but they are going to be, in the near-term, slower in decision-making. It’s for all the reasons I’ve listed above, but also because they all know that with each coming week, more information about the pandemic and its effects will surface. Each week, that information is likely to be worse than the week before. And as the economy gyrates as this new information comes out, over the next 4-8 weeks everyone will have a better sense of what the impact is and will be — and so much can happen during this time, such as stimulus bills, industrial collapses, having a loved one get sick — that I believe most VCs will simply let this play out a bit more before making a big decision. Private round sizes and valuations have been very high. Most investors active today haven’t experienced the pricing pressure that occurs during a downturn, myself included. It’s important to remember, these decisions are mostly irreversible — the money going to a CEO or founder can’t be taken back. The firm name sticks on the cap table. Given that permanence, founders should expect the VCs they’re pitching and targeting to be readjusting at home, among their colleagues, and to the market overall before making their next big decision.