Not really. But it does change the complexion of the industry materially. While the focus in the past may have been on financing portfolio companies that show the best growth prospects, the new reality is keeping portfolio companies alive long enough to be able to figure out which ones can pivot or excel amid the new economic backdrop. General partners everywhere have made it clear to their portfolio companies that costs must be cut materially to extend operating runway.
The good news is that venture capitalists invest for the long haul. Those startups that can modify their business model to survive an extended economic downturn may prove to be the investment darlings of the future. Meanwhile, at the operating level, there are an assortment of difficult questions that have to be answered. How severe will salary cuts be? What sort of personnel retrenchment is required? Venture capitalists will be relentless in demanding ongoing restructuring. An important tenet for startup founders: The venture capitalist considers their client to be the investor, not the startup founder. Pain will be pushed downstream to portfolio companies.
Our concern is that early-stage funding worldwide may evaporate completely. That view is consistent with what the venture-capital industry has experienced in China. According to one study, investments in China collapsed by 60% between the first quarter of 2019 and the same period this year. The same study showed only 20 seed-stage investments in China in the first three months of 2020. The data should be alarming, if not terrifying, for companies elsewhere now in search of funding.
The venture-capital industry indeed has cash at the sidelines, but given a harsh, survival mindset, some pundits argue there is no market for new investments. Unconventionally, we think there is. One caveat: startup founders will have to work harder, for a longer period of time, to find capital than in the past. Consider these points:
Smaller Amounts. Venture capitalists are unlikely to ignore sensible opportunities in part because early-stage investment is characterized by limited-size allocations. The question for startup founders is how are they going to amplify the constrained amounts of capital that may in fact be available. Whereas a venture capitalist may have once allocated $1 million to a startup opportunity, the number may now be $400K.
New Opportunities. Venture capitalist are as well-tuned as anyone to structural changes in the economy, if not more so. The coronavirus outbreak has turbo-charged a new breed of companies that can exploit behavioral shifts. With more people working at home than ever before, digital technologies centered on remote learning and healthcare, for example, may discover an ever-expanding market.
Fresh Motives. The world looks different for venture capitalists than startup founders. Venture capitalists may become the true investment bankers of the future, using their balancing sheets to nurture ideas that complement other portfolio companies. Funding metrics that eye traditional IPO exit strategies may become less relevant, as venture capitalists look to mergers and brand extensions within their own set of holdings.
The high-flying days of Silicon Valley funding blitz-scaled companies are probably over. But fortunately, the venture-capital industry is much deeper than headlines suggest. Early-stage funders will be more prominent because they can focus on baseline operating metrics for a new generation of startups in ways that the heavily-backed venture capitalists cannot. In effect, seed investors are poised to be more prominent than ever before.
One thing is certain. Venture capitalists and startups share a common interest: survival. Venture capitalists will center their attention on where they can best serve their investors. That focus will be with young companies that may have been overlooked last year. For their part, small and nimble, if not skeletal, business ventures are likely to be far better at this survival game than bloated growth-driven firms. ■
Our Vantage Point: Seed and early-stage venture capital will become a new hot spot. These players benefit by targeting companies that are flexible in their operating profile, require smaller funding amounts, and can easily address emerging economic trends.
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