In our last piece, 6 Emerging Tech Trends for a Post-Covid19 World, we discussed trends that we at Catapult were seeing emerge from the current crisis. The post focused on sectors and themes across the technology landscape that have been enjoying a Covid19 ‘bounce’ or, at the very least, renewed interest from tech investors who feel, as we do, that companies focusing in these areas are well positioned to benefit from the changes in consumer behavior and commerce provoked by the pandemic.
In this post, we’ll offer 4 brief insights into what we’re currently seeing in the funding environment. Hopefully, this will provide some clarity to startup teams, fellow venture investors, and limited partners (LP) who are seeking to best navigate the current market uncertainty and position themselves for the road ahead.
1. Portfolio ‘triage’ is non-trivial, but starting to abate.
As has been widely reported, many venture funds — especially those with established, mature portfolios — are having to spend much of their time going through their portfolios and systematically categorizing their companies according to immediate cash needs, runway, overall performance and other metrics. Funds are assessing their own reserves and having state-of-the-union type conversations with portfolio company teams to set expectations for the coming few quarters. This is particularly the case with funds with many mezzanine or later stage companies that have large cash burns and sizable headcounts that could require right sizing. Not surprisingly, this takes time to unwind as these conversations are complex, often uncomfortable, and can involve arriving at difficult decisions.
This presents obvious challenges to startups in a fundraising process that are seeking an audience with those venture funds that have largely turned their focus to internal matters. The good news, however, is that there are signs that this is beginning to abate. Shortly after the first market gyrations of late February, many funds got out in front of this cycle and began putting out their biggest fires first, which has allowed them to now slowly increase new deal originations and to have more ‘pipeline’ conversations with new relationships. As such, while getting on the Zoom schedule with a partner with check-writing authority at a fund that’s digging out of portfolio challenges is still difficult, it’s a lot easier than it was a month ago.
Clearly, this is also a fund-by-fund issue. Some firms with more troubled companies will be more preoccupied than others with firefighting distractions this year. Fortunately, this is not quite the case for newer funds without a legacy overhang of prior investments requiring attention. With valuations coming down, along with lower operating costs and more talent available, this is an exceptional time for newer funds unburdened by troubled companies to triage to be deploying capital on new investments.
2. Cadence of fundings at Seed/Early stage increasing whereas Mezz/Late stage companies still face challenges.
Of the investments that are closing, there is a clear bias toward Seed and early stage rounds. On one level, this is predictable: Seed/Early stage round check sizes are smaller; there is less of a company or product to diligence; and, funds are typically more comfortable approving and funding a $500k investment in a company they’ve never met in person than one they would for, say, $10mm.
On another level, this uptick has a lot to do with the market environment facing a Seed/early stage company versus a more mature one, and the kinds of expectations attached to a Seed investment. Investors understand that, typically, the first two years after funding a Seed stage company will be dedicated to building the product or service, not profitability or concerns about near-term macroeconomic conditions. In many ways, this makes a bearish market like the one we are experiencing now and will likely continue to inhabit for the rest of this year ideal for funding and growing a Seed stage company — a point we covered in detail in a prior post, The Bull Case for Venture Capital in a coming Bear Market.
In contrast, later stage companies are viewed through an alternate lens by investors and held to a different standard. The expectations are also different. Near-term market conditions carry much more weight; and, unless the company is in a sector that will likely be a clear beneficiary of Covid-19, those near-term market conditions are not terribly favorable.
Additionally, the pandemic has altered the late stage funding landscape which has, in turn, ratcheted up financing risk for many late stage companies that continue to burn cash. Six months ago when there seemed no shortage of Fund-of-Funds, Corporate Venture Funds(CVCs), and family offices eager to invest in promising later stage companies, financing risk was considerably mitigated. This is not the case today. While there is still a good amount of late stage capital available from non-traditional investors, it seems to be accessible now only by the strongest and most sought-after companies.
3. Overall mood improving as notions of the “new normal” come into view
While it’s still early days, in recent weeks the overall mood seems to have improved among broad constituencies in the asset class. The panicky nervousness of investors that seemed ubiquitous in the weeks following the market’s tumbles in late February and during the early weeks of shelter-in-place seems now to have been replaced with a more muted tone. Investors remain concerned, to be sure, but there now seem to be boundaries around those concerns and around what we can expect in the months ahead. Many investment mandates that were entirely put on hold in early March have now been re-activated. The performance the Dow, now that it’s recovered more than 60% of its losses since the market bottom in early March, has certainly helped; so, too, has the strong performance of the tech-heavy NASDAQ. This all serves as a harbinger that tech, writ large, is poised to perform well in a post-Covid world.
On the GP side, fundraising remains robust. There has been a record number of $1Bn+ venture funds raised in just the past quarter. While many of these fundraising conversations were already well advanced before Covid19 hit, there were still a number of funds that began marketing and had closes while the markets were just coming to grips with the pandemic. While some LPs have backed away from participating in these funds, there has been no shortage of other LPs willing to seize an opportunity to access a manager it long wanted to access and, thus, stepping in to take those available allocations.
4. Companies now need to prove they’re a Covid benificiary or are Covid-resilient
Finally, another evolution we are seeing is the kind of companies that are successfully raising capital now. While hotly competitive companies and those with high-profiles but perceived to only be temporarily impacted by Covid have closed financings in this environment, most companies securing new rounds are either clear beneficiaries of the post-Covid environment or possess a Covid-resilient business model. As such, founders are well advised to embrace the current market realities in their investor collateral and make a cogent case for how their businesses will prosper in this post-Covid world. Clinging to a marketing plan or investor deck from six months ago will appear to investors oddly tone-deaf. A better approach is to address the “elephant in the room” early in investor conversations, demonstrate how the current environment is ideal for the company’s product/service (or at least does not meaningfully impact it) and lay out a clear 18–24 month roadmap for how the company plans to navigate it successfully and emerge as an ostensible leader in its category.