Delving into the many layers of startup funding during the Covid-19 crisis
It’s the question that’s been on everyone’s minds: what happens to startup funding in the age of Covid-19 when no business can reliably be expected to survive?
With fewer resources, little experience in weathering cataclysmic market events like the pandemic, few profit reserves to fall back on, and critical plunges in revenue across the board, startups have been among the worst affected by the unchecked spread of the coronavirus.
As it stands now, six months in at the time of writing, the issue doesn’t lie in the availability of funds. Dry powder in the VC sector is practically overflowing: Preqin estimated it at US$276 billion, and KPMG placed it at $189 billion. Whatever the number, there seem to be plenty of capital commitments to go around.
However, the pandemic may force investors to make some unpleasant decisions. For one, instead of funding the growth of new, potentially profitable ventures, some of it will necessarily have to be dedicated to propping up existing portfolio companies. Second, valuations are likely to experience a correction. Third, many VCs will need to continue signing term sheets, no matter their personal take on the issue, in order to keep to timelines and keep returns on track for ongoing investments.
But continued investment flows are no guarantee of normalcy in capital markets. The pressures of the ongoing crisis almost definitely mean more prolonged and intensive dealmaking processes. For many investors, a gut feeling about the transformative power of a tech solution will no longer suffice–cold, hard numbers will be the name of the game.
Changes in deal activity and sectoral growth
The past months have been characterized by an undeniable slump in deal volume. An April PitchBook report found that deal activity was down by 26% in March. On the corporate venture capital (CVC) side–which is suffering from the same setbacks, but with exponentially greater ability to withstand losses–CBInsights found a 24% year-on-year decline in deals.
While KPMG found that $61 billion was raised across 4,260 venture capital deals in Q1 2020, the report also included an ominous statement declaring that the first quarter of the year would be the “calm before the storm.” Although Asian companies raised mammoth rounds (including GO-JEK, whose Series F continues to grow and stands at $3 billion at the time of writing), dealmaking across the Asia-Pacific region fell from 23.4% of the global total in 2019 to 19.4% in 2020 (PitchBook).
“While we have observed a slight slowdown in the overall number of startups that are actively seeking funding, we also see increased activity from companies in sectors that benefit from the Covid-19 situation,” says Justin Nguyen, Partner at Singapore-based VC firm Monk’s Hill Ventures, in an email exchange.
These sectors include ecommerce, healthtech, remote working, and edtech, which have all picked up thanks to global lockdowns and the work-from-home experiment. Indian food delivery platforms Swiggy and BigBasket, for instance, picked up back-to-back rounds on April 6 and April 9 of $43 million and $60 million, respectively. Chinese edtech startup Yuanfudao raised a $1 billion Series G round on March 31.
“In general, there is certainly an allure to a company that is able to achieve explosive growth by benefiting from the Covid-19 situation,” Nguyen says. That said, he adds that investors will “also evaluate how their solution or product will be received after the downturn.”
Nguyen says that a pickup in VC deal volume depends on investor confidence in the market and the effectiveness of government containment measures.
“We have seen venture capital funding rally in China, the original epicenter of the virus, after the lockdown measures were lifted,” says Nguyen. He expects a similar uptick once other economies begin to contain the virus and successfully recover from its effects.
Lengthier deal-making processes
Another likely effect of restricted travel and ongoing lockdowns is that the dealmaking process will become significantly more time-consuming.
Funding deals are generally months in the making, involving meetings and a lengthy due diligence process into the company and founders, which can take weeks. A great deal of trust and camaraderie needs to be built between founders and investors, and the limited partners who contribute to VC funds need to be assured of the validity of the startup’s proposition. All this now has to take place in an online medium.
“We’re seeing that recent funding rounds are investments into companies where the founders began conversations with the investors well before Covid-19, as investors are likely uncomfortable with making new investments without meeting the founders and team in person,” Nguyen says.
He adds that founders in need of funding may have more success approaching existing investors with whom they have already developed relationships. Unable to meet face-to-face with prospective investors, Nguyen suggests that founders prepare for longer and more numerous rounds of meetings in the buildup to a fundraise.
While he says that there is still dry powder to fund continued investment, Nguyen emphasizes that investors will want to see founders prioritizing profitability as opposed to top-line revenue growth.
“Early-stage VCs want to fund growth as opposed to survivability, so a key deciding factor for investors is whether the company is looking for investment to possibly fund bad unit-economics, or if the funds will be used to strengthen an already sound business or even capture opportunistic growth during the Covid-19 situation,” he says.
The pandemic’s impact on startup valuations must also be considered. In an analysis of the effect of the dot-com crash versus the 2008 Global Financial Crisis on startup valuations, Madrona Ventures Principal Daniel Li suggested that historical data indicate an oncoming drop in valuations, particularly for later-stage startups, with the recovery based on the performance of public tech stocks.
“Later stage startups are more sensitive to the public markets because investors use public companies as comparables to set valuations, and that’s reflected in the historical data for Series C and D rounds,” he wrote.
Exits, LP commitments, and a view to the near future
While the world is caught up in trying to make predictions for global markets, VC fundraising –which is generally more a grey area from a capital markets perspective–seems to be one area where the next steps and probable impacts of Covid-19 are quite clear.
Following a disastrous year for tech IPOs, and with the stock market now in dire straits, it’s evident that 2020 will not be a year for triumphant public listings. KPMG explains the situation as Covid-19 “basically slamming the IPO market door shut,” suggesting that bridge rounds of emergency funding may be required in many instances.
Airbnb is one such example. The company was due to list this year, but was hit extremely hard by travel restrictions. It raised two rounds of $1 billion in debt-equity deals within two weeks in April, before being forced to lay off a quarter of its workforce a month later.
In addition, the upcoming U.S. presidential election is expected to contribute some degree of additional volatility to public markets, as is always the case.
Meanwhile, on the VC side, the record amount of dry powder on hand are, in part, just capital calls, or legal commitments allowing investment firms to demand promised funds from limited partners (LPs). However, if the LPs themselves are experiencing liquidity crunches, there may not be much actual money in the bank to support dealmaking.
All the signs seem to point toward one thing: an inevitable slowdown in dealmaking and fundraising. However, a slowdown doesn’t mean a full stop.
“At the end of the day, we continue to take a long-term view and will continue to look for great founders and companies that are solving big problems with solid unit economics,” says Justin Nguyen.
This environment means that expectations need to be managed, and the right steps taken to ensure startups have enough runway to get through the crisis. It can also be said that those who secure funding during this turbulent time are likely to be the most decisive founders with the smartest business models.
The startup ecosystem has always been Darwinian, but Covid-19 fundraising has revealed just how challenging survival can be.
Nayantara is Jumpstart’s Editorial Associate.
