How Startup Investors are Responding to COVID-19

Apr 16, 2020

 

And What Startups Need to Know

Fundraising for your startup can be challenging at the best of times. In the midst of a global pandemic and the economic consequences that come with it, raising capital will be even more difficult. From conversations with venture capitalists, large private investors, and angels there seems to be a consensus about how COVID-19 is affecting their investment decisions. Deals are still being signed and cash is still available, but the bar startups have to reach to attract investors has lifted and valuations are taking a hit.

If nothing else, it’s clear the next 12 months aren't going to be easy. Craig Blair of Airtree Ventures, one of the largest venture capital firms in Australia, has said “This is the toughest economic & health crisis that I’ve seen in my lifetime.”.

 

It was great while it lasted

It’s important to recognise where we’ve come from. The last 11 years have been fantastic for startups and investment. For reference, the stock market has seen the longest period of positive growth in its history. Between 2010 and 2019 the average size of seed funding rounds for US startups grew from $1.3 million to over $5 million USD. For comparison the average seed round in New Zealand today is about $400 thousand.

It was great while it lasted, but now it’s over. We’re likely headed for a tightening capital market. That means it’s going to be harder for startups to raise cash. How much harder? No one knows, but we can form a hypothesis with the help of a few people who have been through downturns in the past before.

Over the past few months I have spent a lot of time talking with private investors, professionals in venture capital, and angel investors whilst raising funds for my startup Vxt. When we announced our raise in early February, our team was very confident we’d be able to fulfill our funding round with an aggressive valuation. It’s been an interesting time and I’ve personally learned a lot from people with decades of experience in the investment community. For this article, I reached out to some very well respected investors for their thoughts on the current situation and what we can expect over the next 6, 12 and 18 months.

 
 

Angel Investment

Angel investors are private individuals who invest a relatively small amount of money in early stage startups hoping to make high returns. Compared to venture capital firms which we’ll discuss later on, the angel investment community is extraordinarily diverse which makes it harder to determine how they might react. The term “angel” was first used to describe wealthy people who provide money to propel theatrical productions on Broadway. Angel investors tend to have their cash in a variety of pots, including the stock market. As you’re probably aware the stock market has been hit particularly hard by the COVID downturn. In fact, the recent crash was the fastest drop of this size in history. Having probably lost quite a lot of money as a result, angel investors are likely to have much lower willingness to invest in the short term.

What does this mean for startups? Ben Kepes, a local angel investor and successful entrepreneur says, “Money will be tight, valuations will be down and investors will be WAY more cautious about picking companies that actually solve a real problem.”.

 

Venture Capital

Venture capital firms are usually government, semi-government, or private companies that invest in startups with high growth potential. Venture capital firms in particular tend to focus on investing in ambitious startups aiming for billion dollar exits.

Venture firms tend to invest in companies with the expectation that they won’t see returns for more than ten years. This means that venture capital will probably be the least affected by the market downturn. “Most of the top VC funds in Australia still have sufficient capital to continue investing, so I don’t think that capital, or lack of it will slow down investments in the very short term” says Garry Visontay, a partner at Right Click Capital venture capital firm based in Sydney, Australia. However, VC firms have traditionally focused on bigger deals in later stage companies. So while startups looking for cash from venture capital shouldn’t be in trouble, it’s not much help for companies earlier along in their startup journey. In fact, there’s a mountain of venture capital available for the right companies. In 2018 almost $900 million dollars of venture funding was deployed to startups by Australian funds. While venture cash isn’t going away anytime soon, there seems to be a noticeable change in valuations, Visontay continues, “US VC’s are already talking about 20-30% devaluations occurring and becoming the norm”. 

 

So what does this all mean?

Why are valuations dropping? The simple answer is, with the heightened anxiety that we’re all feeling, entrepreneurs aren’t as bold as they might be in a bull market. We’re all dropping our valuations in order to remain competitive in a market full of startups looking for cash. As valuations drop and investors pull out of the market, presumably, good investors are staying in to snatch up better deals. So what can we do to make the best of a bad time? The answer to that depends on your business. Surround yourself with great advisors, mentors and colleagues. Together, I’m sure you’ll come out of this turmoil stronger. Pressure makes diamonds.



- Luke Campbell, CEO of VXT

 
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