Updated: Jan 17
Now more than ever, we can lean in to our society’s needs for strategic investments, optimize our investment operations and seek to further support our partners during these turbulent times.
This article looks at the following:
The changing dynamics of the investment industry.
LP, VC & Startup insights.
General advice for VC’s and Startups in navigating these turbulent times.
While Covid-19’s impact on the investment industry is not nearly as high a priority as protecting people’s health and well-being, it is still of utmost importance to learn more about the changing dynamics and our ecosystem partners ‘ response to it. Now more than ever, we can lean in to our society’s needs for strategic investments, optimize our investment operations and seek to further support our partners during these turbulent times. Below insights are based on several talks with VC’s, LP’s and startups as well as a deep dive into the analyst reports provided by fellow ecosystem partners over the past two months — May & June 2020.
Changing dynamics of the investment industry
Global growth is projected at –4.9% percent in 2020 according to IMF (economic outlook June’20), which is 1.9% points below the April 2020 World Economic Outlook forecast. The COVID-19 pandemic has had a more negative impact on activity in the first half of 2020 than anticipated, and the recovery is projected to be more gradual than previously forecasted. In 2021 global growth is projected at 5.4%. Overall, this would leave 2021 GDP some 6½ percentage points lower than in the pre-COVID-19 projections of January 2020. In the baseline, global activity is expected to trough in the second quarter of 2020, recovering thereafter. In 2021 growth is projected to strengthen to 5.4%, 0.4 % point lower than the April forecast. Consumption is projected to strengthen gradually next year, and investment is also expected to firm up, but to remain subdued. Global GDP for the year 2021 as a whole is forecasted to just exceed its 2019 level.
Private Equity Market
The numbers through April’20 show that the coronavirus pandemic has put the brakes on buyouts, exits, fund-raising and returns. The industry is already experiencing a sharp drop-off in global buyout and exit transactions according to Bain & Company. The number of buyout transactions fell 60% from January to April. GP’s have largely focused on stabilizing portfolios; sellers have been reluctant to sell their companies as valuations are coming down while other ecosystem stakeholders are still trying to figure out how to assess risk amid deep macroeconomic uncertainty. The number of exit transactions has fallen 72% since January as funds are withholding from selling. However, a record level of dry powder in the market continues to pressure funds to find and do deals. In April, private equity funds were sitting on a $2.6 trillion in unspent capital. But with markets roiled by volatility and cash-strapped companies struggling just to figure out what demand is going to look like in the coming year, the mix of opportunities has shifted substantially.
Fund-raising on the other hand seems to be right in line with previous years. Up till April funds have raised $287 billion globally. The disclaimer here though is that the money raised in those four months actually reflect the efforts that preceded the crisis. It is expected that LP’s will trim capital invested with PE fund over the next 6 months.
Global Startup Economy
The global startup economy remains large, creating nearly $3 trillion in value, a figure on par with the GDP of a G7 economy. 2019 saw close to $300 billion in venture capital investments around the world according to crunchbase. The lockdown measures as a response to the spread of the new coronavirus however threatens the existence of many innovative startups. Our sentiment analysis suggests that while startups are successfully leveraging their available resources as a first response to the crisis, their growth and innovation potential are at risk. Therefore, policy measures should not only provide first aid to startups by alleviating the pressure caused by constrained cash flow, but also involve long-term measures embedded in and supported by the wider entrepreneurial ecosystem to ensure rapid recovery and growth.
LP’s indicated to expect a lag in private markets relative to public markets. Overall LP liquidity appears strong according to First Republic Bank as only a minority of the LP’s surveyed remarked they would look to transfer commitments or ask for a delayed call. None of the survey respondents said that they were at risk of defaulting. They do however observe a capital shift in particular funds. Hedge funds and family offices for instance are temporarily exiting late stage private investing to be able to focus on public markets opportunities. Hospitals and universities may need to spend more money on operations and will be less liberal with their investments.
Their current observation of valuations is that they are coming down 20–30% and that round sizes will reflect that for dilution. Technology and innovation aren’t correlated to the markets. New investments are still building products and will come to market after this cycle turn. LP’s are therefore revising the 2–3 year time frame in terms of the investment strategy. They expect this crisis to have an ecosystem ripple effect and emphasize the need to over-communicate about working arrangements, acknowledge some fallout in the portfolio due to business risk and increased financing risk, and provide guidance on capital calls/pacing over the next 3–6 months. Furthermore, the First Republic Bank expects LP’s allocation into new managers in 2020 to mirror 2019, with the exception of pension funds. Confidence in VC remains high and LP’s seems to be warming to the idea of allocating without an in-person meeting as nearly 60% of both non-institutional and institutional investors said they would allocate without a site visit.
Similarly to the other ecosystem stakeholders, VC’s too have experienced the effect of this crisis and are gearing up their defense and offense strategies to navigate these turbulent times. According to a recent study Kaufmann Fellows carried out a majority of VC’s interviewed expects capital deployment to slow down and raising capital from LP’s to be harder. 57% will stay the course with their existing follow-on strategy and the remainder will provide more follow-on investments to support portfolio companies. Many venture capitalists feel a deep responsibility to support their current portfolio companies and do so in a variety of ways through; funding, mentorship & coaching, strategy & financial planning, navigating government stimulus and support packages, and communication.
In our talks with VC’s we have also learned more about the investment strategies with regards to specific focus areas. The first observations we were able to make is that themed funds/VC’s do not shift their investment strategies. Taken the current situation into account, capital intensive companies with high burn-rates, those that rely on offline transactions or in-person traffic are likely to get hit. These focus areas would be; travel, retail, hospitality, brick and mortar etc. Naturally, there is a strong demand for solutions and focus areas that are able to stop the spreading of covid-19 and solutions that are able to support our new way of working, studying and living. The second observation here is that although the majority of VC’s stick to their original focus areas, they are also diversifying their capital allocations in verticals such as; healthcare, the digital space and solutions that accommodate remote activities.
General advice for VC’s
Raising/Closing. Understand where you stand in your LPs’ portfolios. There will be a lot of funds trying to wrap up in the fall. If you are stuck fundraising, give LPs a little break to find their footing while maintaining the relationship.
Anticipate the LP questions and take them through your portfolio analysis proactively.
Revise your portfolio and determine which companies retain option value and where you must concentrate capital.
Lean in to a more diverse set of real-time sources to obtain data and insights.
Show empathy toward the human in the process in dealing with this stressful situation.
Reach out to your portfolio companies and show support.
Have board meetings with portfolio companies as often as needed.
Create a sense of community where you dedicate yourself towards navigating this process together.
Help startups navigate the many new government stimulus and support packages.
Keep communication channels as open as possible.
In the current situation, startups are most likely to be hit harder due to the nature of the company’s life cycle and its specific needs and most notably funding or cash reserves. According to Startup Genome, without additional loans, subsidies or benevolent investors, almost half of all start-ups in the world fail due to the corona crisis. As a consequence of the lockdown almost 75% of startups have had to let personnel go, 60% had reduced spending and 16% experienced a drop in revenue streams. The latter being mostly in the focus areas affected by the pandemic. Where many startups will have to focus on defense strategies others are able to thrive during this period as demand increases for their specific solutions. Just like previous crises, this pandemic too infuses entrepreneurship and will give birth to high impact solutions.
General advice for Startups
You must have a strong bias towards action. Actions and strategies planned and revised today will either strengthen of break you a year of two down the line.
Make sure to only look at elements that require a change in strategy and don’t overreact. A complete overhaul of your business model is not necessarily the solution.
Check your cash burn and figure out how to get to a 2–3 years of cash. This could also include fundraising, a stockpile, contingency fund or pricing or payment changes with customers.
Pitching/VC relationship. Clearly articulate and visualize a compelling growth & value creation opportunity.
Show more, demo more often and share more data to influence your stakeholders (e.g VC’s).
Expect more inside rounds. Many VCs are focusing first on their own portfolio in terms of funding, and then will look externally in a few months.
Stress test your revenue streams, revise your customer accounts and determine your area of focus.
Be transparent in communication towards your employees and ensure a stable environment.
Take advantage of this opportunity to revise your operations, run your business more efficiently or reposition your company to address the unmet needs in our society.
Furthermore, as one the VC’s mentioned “Venture capital is part of the solution to this perfect storm, and backing our founders is how this world will find a new, healthier, more sustainable equilibrium. I’m excited to do our part backing innovators making the world a better place”. We are in this together and the more we are able to support each other the more we can steer our energies towards positivity and a ‘new normal’ world post covid-19.
We are keen to support our ecosystem members and continue the dialogue of the ongoing implications of covid-19 on the investment industry. Feel free to reach out to our founder directly via email@example.com.