How the Venture Capital Ecosystem is Shifting and What Founders Should Consider
By: Oliver Kicks
Tags: Startup Lessons, Covid 19, Venture Capital, Startup

“Tough times never last but tough people always do” — Robert H. Schuller

We thought we’d start on a positive note since everything in recent news has been extremely tough to swallow. A number of industry participants will face extreme difficulties re-entering the market, as companies look to mitigate risk and adapt to the widespread reorganisation of the status-quo. But change isn’t always bad. Whilst we hope working people and governments can navigate a downturn as smoothly as possible, the VC industry has and always will look for disruptors through the tough times. We only need to look back to 2008/09 to see what companies were founded during the Financial Crisis.

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With billions of dollars in combined market cap, the aforementioned companies and their respective founders were not deterred by the macro environment — and we anticipate this trend occurring this time around.

VC’s ultimately look to invest in disruptors. As layoffs continue to mount, the societal and economic order of the last decade evaporates, leaving creative approaches and unique business models to flow into the empty spaces. We can only speculate as to what themes will begin to capture mainstream dollars, in a post-COVID world. Remote society (work, leisure, socialising, manufacturing, governing) seems an obvious place to start.

What lies ahead is undeniable uncertainty. Speculation will continue until testing becomes more widespread and concrete data can inform governments globally on the best route to recovery. Until then, measures will continue to be taken to slow the spread of COVID-19, ultimately slowing economic activity, which will lead to the reprioritisation of stakeholder values, and reconsideration of budgets in every organisation globally.

The Funding Side

Since we began with the silver-lining, we should now look to the cloud itself. The US Tech 100 index has fallen over 30% since the coronavirus outbreak and we can, of course, expect this to have an impact on early-stage deal valuation. The pain being experienced in public markets will have an inevitable knock-on effect on private markets also, albeit with a few weeks delay. Decreased liquidity on the public side will lead to a slow-down in M&A activity. Providing transactions are still going though, lower exit valuations (and returns for VC’s and their LP’s) can be expected, and in most cases, routes to exit are quickly slamming shut.

Changes towards the rear-end of a VC funds cycle will also change their approach toward the front, new deals. First and foremost, we might expect to see an increased appetite for deal sharing and co-investment, in order to mitigate risk and reduce ownership exposure. With increased downward pressure on early-stage companies, failure-rates may be expected to rise, and this may call for additional diversification. The impending recession will mean firms may need to share more information and internal knowledge, in order to ensure the ecosystem continues to thrive. The absurdly competitive nature which has been witnessed over the last period of growth may begin to wane, as investors look to one another for reassurance amongst times of uncertainty.

Eric Hippeau, managing partner at New York-based VC firm Lerer Hippeau, experienced what it was like to be involved in fundraising in the aftermath of a recession. Historically, startups might find it difficult to raise capital if recession warning signs are flashing red. But according to Hippeau, “capital will continue to be deployed the same way it was after the Great Recession — cautiously.” Cautious investing will likely mean that the “maybe’s” will be crowded out and only the marquee deals will see daylight.

However, according to Pitchbook data as of June 2019, VC Funds are collectively sitting on $189 billion of “dry powder” which could mean that despite the imminent recession, funds continue to have a lot of capital to deploy.