The dollars and cents of raising VC during the coronavirus pandemic

March 15, 2020

The novel coronavirus is raging across the planet. Millions are quarantined, the stock market is violently gyrating and one of the preeminent VC firms in the Valley is back to saying RIP Good Times. The daily stream of news is terrifying, and we are going to learn even more in the coming weeks.

 

For founders, the biggest challenge is inoculating their teams from the vagaries of the market so they can do their jobs, continue building momentum against this market adversity and, ultimately, ensure there is enough cash in the bank to avoid layoffs and sustain their company for growth.

 

I want to talk today about the money details, saving some of those other topics for future posts. What does VC fundraising look like today? What’s going to change in the VC market? What might actually get better about fundraising today than just a few months ago? The daily headlines can be traumatizing, but with the right approach, you can navigate these waters safely.

 

Volatility affects different VCs differently

Perhaps nothing is more important in the fundraising landscape than volatility in the stock market. As much as venture, and particularly early-stage venture, is far, far away from the public markets, the reality is that all markets are inter-connected and what happens in one affects all the others. Let me give some examples.

 

VCs need to raise funds from limited partners that have less money to put into their alternatives portfolio since the market has crashed. In fact, those LPs may want to double down on the lower prices available on the stock market and actively direct money away from locked-up alternatives with long-term horizons to public equities in the hope of making a relatively quick buck now.

 

There are a variety of ways that companies are valued on a VC fund’s investment sheet, but among the most common is “mark to market.” That’s where a company is compared to a basket of similar companies on the public market in order to derive a valuation for that company. So, for instance, a SaaS company might be marked against a variety of public cloud and SaaS companies like SalesForce, Zoom, Datadog and others based on its ARR and growth metrics.

 

As the markets have tanked, so have these mark-to-market comparisons, which means VCs are looking at negative declines in many of their portfolio valuations — even if the underlying companies are doing just as fine as always. Those devaluations are going to affect a VC’s own ability to fundraise from LPs, their desire to hang tight and wait out the storm and their own psychology and optimism — which directly affects their excitement to invest in new, speculative projects.

 

Next, for some very early-stage investors at the angel stage who might be running a family office (or themselves are the family), declines in the markets may effectively prevent them from having the cash liquidity to invest in promising startups at all. Some of these investors may not want to sell stock at a low price just to get some cash to invest in alternative assets, and may effectively exclude themselves from the fundraising market for a while until the markets improve.

 

In other words, what happens on the Nasdaq does affect startup fundraising, even if the two might seem a half-dozen rounds apart from each other. That’s one of the reasons why my colleague Alex Wilhelm covers the ups and downs on Wall Street so feverishly — it’s a huge signal about what is happening elsewhere in the market.

 

And given that the news has been pretty uniformly negative, it seems obvious that many VCs are going to pare back their investing in the short to mid-term.

 

Yet, not all VCs will pull back

As I have said ad nauseam this year, VCs are in a hyper-competitive market like we have never seen before. There are more VCs, VC firms and VC dollars in more geos worldwide prowling for the next startup than ever.

 

The coronavirus outbreak has not changed this basic thesis in the market.

 

Some VCs will certainly pull back from the markets due to their LP fundraising challenges or portfolio management practices. But for many other VCs, there is opportunity here — and they may never get another moment like this again for some time.

 

I have heard from a smattering of VCs (not enough to call it a trend mind you, but still) that they actually intend to double down in the coming weeks on investing. Why? Because with other investors departing the market, deal terms are getting better, the competition is less keen, they can do more due diligence and there are a lot of companies being built that have great growth prospects and are going to survive this global pandemic.

 

It’s the VC equivalent of buy (actually) low and sell high.

 

Let’s get one thing straight: Fundraising isn’t a binary. It’s not whether you succeed at fundraising or fail. Fundraising is a spectrum: How many dollars do you raise and at what price? What are the terms attached to that term sheet and how much future flexibility do they afford you?

 

There is no doubt in my mind that the coronavirus will dampen enthusiasm for startup investing and thus lower valuations. That’s reality, and a product of the supply and demand of investors in the market. However, that doesn’t mean that all term sheets just got frozen in legal with no chance of ever seeing ink signatures on the wire sheets.

 

Instead, expect that the valuation you might have received even a few weeks ago has declined, maybe as much as 20-30% right now. But at that new valuation, there is almost certainly a line of VCs waiting to invest in promising startups with a discount on valuation.

 

As a founder, it might suck that, due to timing, you are coming up on a fundraise just as we are hitting peak coronavirus scare. If you can cash-manage your burn and potentially get out of this fear window, then by all means do so.

 

But remember, startups take an average of more than a decade to get to the public markets these days, and often raise more than six rounds of venture capital across their lifespans. Every single one of these rounds can’t be perfectly timed. One of them is going to be the relatively hardest one of the set (just as much as one of them was the relatively easiest among them). This fundraise may well be your tougher fundraise, and it may cost you some extra dilution than you might have anticipated. Frankly, that’s life, and one of your rounds was almost certainly going to be a harder one. It might as well be this one.

 

Is it possible to fundraise today? Absolutely. Will it be as easy as before? Almost certainly not. Will valuations sink a bit? Yes, almost certainly. But should all that worry you? No, no and no. You should be going into every fundraise with the mentality that it will be arduous, that no additional capital will ever be found again and then be pleasantly surprised at the result. This one is no different.

 

Fundraising in today’s market

The biggest challenge today is going to be maintaining momentum during a fundraise. A lot of investors are going to wait and see, and you must identify those investors and cut down on your contacts with them. Focus on those that proactively talk about the coronavirus, but seem sincere in wanting to commit to your startup despite the global macro environment. As always, choosing the right VCs that propel a fundraise forward is the core of fundraising, and so this isn’t exactly novel advice.

 

One big challenge on keeping momentum will be handling all the new “no in-person meetings” policies that have sprung up at some Sand Hill offices. Raising funds, particularly post-seed, is nearly impossible virtually. I’ve seen it happen regularly with $50K and $100K seed checks (I’ve seen such checks written over a 20-minute Skype call). I have never seen it personally when millions of dollars are at stake. You need to meet your investors, just as they need to meet you. The coronavirus or not, these folks are still going to be on your board and be with you for the next decade.

 

It’s a changing situation, so it is hard to give long-term advice here. Instead, I would emphasize that you meet in person with those you can, work with those who only want to do so virtually and do your best to identify who is just wasting your time and who might actually move forward with an investment in spite of the lack of an in-person meeting. My guess is that the number of VCs on your final fundraise list will be smaller, but there will still be competition among them, assuming the core of a business is solid.

 

In short then, the novel coronavirus is adding huge ambiguity to the futures of a lot of startups. But ambiguity is what founders navigate, literally every single day. This issue, like every other issue that comes up in the activities of building a company, is no different. Ask for advice from other founders and advisers. Listen to the feedback people tell you. Get creative about how to connect with new folks as quarantines and lockdowns persist. Husband your capital, but realize that now might be a moment of growth rather than merely stagnation.

 

Do what you can with what you have. That’s all you can ever be expected to do.

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