The coronavirus pandemic has changed everything, including how companies raise venture funding. It has become a slower, shakier process, in part because VCs and startup founders can no longer meet in person.
“Much of communication between people is non-verbal,” Russ Wilcox, a partner at Pillar VC, told Built In.
Specifically, he said, a lot of emotional and tonal information comes through in our vast catalog of microexpressions; to date, psychologist Paul Ekman has counted more than 3,000 of them.
“Sometimes, you may know how a person is feeling before he or she knows” through these fleeting expressions, Ekman told the Guardian. “You may also be able to recognize that there is a chance a person is trying to diminish or conceal her expressions.”
This type of information can make or break an investment deal. But flickers of emotion — a raised eyebrow, a suppressed smile — are invisible over the phone, and hard to interpret over video chat, which involves a slight lag and can be “choppy,” Wilcox noted.
“In the previous three recessions, technology adoption has increased.”
“There are also things that you learn when you’re with a team in a room together,” Jackie DiMonte, vice president at Hyde Park Venture Partners, told Built In. “Just how people interact.”
Loss of these subtle cues makes it harder for VCs and founders to develop trust. It also makes it harder for VCs to assess companies.
“You can’t walk a shop floor together and have someone point out, ‘Hey, this machine has been acting up. That’s what your money’s going to be used to do — fix this thing,’” Wilcox said.
But that doesn’t mean VCs aren’t investing during this time. Quite the opposite.
“In the previous three recessions, technology adoption has increased,” Candace Widdoes, chief operating officer at Plug & Play, told Built In, referencing a recent McKinsey study. Companies invested in new software in an effort to boost efficiency and adapt to a new environment — and they probably will again.
So it’s no surprise that VCs keep writing checks. But the investment process, and the market, have changed. We spoke to Wilcox, DiMonte and Widdoes about how the coronavirus pandemic has affected venture funding and tech startups so far — and what might happen next.
Some VC Firms Are Strapped for Cash, but Most Are Still Investing
Russ Wilcox
Partner at Pillar VC
For the VCs who had raised capital one or two years ago, this is a strange time to be investing, but everybody’s OK. For VCs who have run out of cash, and statistically that’s maybe 25 percent of VCs, they’ve planned to raise more capital — and that’s really hard because a lot of fundraising is based on an in-person meeting. That’s true for entrepreneurs too. We’ll probably see less investing in venture funds in the short term. In the long term. I believe that VCs will come out of this and put the pandemic in the rearview mirror. A fund lasts 10 years, and this really is a one- or two-year event.
Candace Widdoes
Chief operating officer at Plug & Play
In terms of funding, the rate of startup fundings was pretty normal last month. It’s definitely tightening this month. If people were raising a Series A, they’re now extending their seed, which means they’re not increasing their valuation. It’s not unexpected, though, just given all the uncertainty in the market. At Plug & Play, specifically, we do 200 investments every year. Last month, we did seven investments. The previous month we did 10 investments, so maybe a tiny drop-off, but we’re still making investments.
Jackie DiMonte
Vice president at Hyde Park Venture Partners
What I’ve heard from folks around the industry is that when coronavirus hit, there was this sort of denominator effect where investors felt overweight in their private equity and venture capital portfolios. If you had a portfolio that was maybe 20 percent of venture capital, and 80 percent was in the public market. When the market drops 30 percent, that value in your public portfolio drops, and suddenly your allocation to venture capital feels much bigger, proportionally, than it did a month ago. So some investors reduced their commitments to managers that they hadn’t closed with yet, or just put a pause on getting involved with new funds.
Seed-Stage Startups Are Better-Positioned to Weather the Storm Than Most
Wilcox: This is a great time to build your product because there’ve been layoffs and now there’s a lot of talent suddenly available. So I think seed-stage venture capital is going to be quite active right now. When you invest in early stage startups, you’re really betting on a sales growth that will happen two or three years in the future. Companies raising a Series A and B, though, are in tough times. They’re cash hungry and their goal is to grow. This is a tough time to grow your revenue; a lot of people may not be buying.
VCs Are Looking Out for ‘Inelastic’ Startups That Can Weather a Recession
Wilcox: Investors are paying extra attention to startups that will benefit from a recession. Two kinds of companies benefit: one is what we call inelastic, meaning that you have to buy from them no matter what. No matter how bad the economy is, you still have to pay your taxes, so you’re still gonna pay your tax accountant. Toilet paper, you still buy.
Then there’s another category, which is things people buy because they’re a more frugal option. Maybe you’re not going to buy a ticket to a Broadway show, but you would buy a premium cable channel like HBO. Right? It’s less expensive. You’re trading down. Same with discount retailers, fast food and casual dining, instead of going to a fancy meal.
They’re Investing in Coronavirus-Relevant Technologies, Like Delivery Drones...
Widdoes: We’ve launched a new virtual accelerator that we’re calling COVID-19 Social Impact Initiative. We’re investing in tracks like health, supply chain, enterprise technologies that can make companies leaner and more efficient. Cybersecurity is a big issue, as we’re all shifting to this virtual world and working remotely. In terms of supply chain technology, I think 3-D printing, additive manufacturing, that’s a big area. Last-mile delivery is big too. A public example of that is Matternet, which has participated in several of our programs. They just signed a deal with UPS and CVS to deliver drugs to the elderly in Florida via drone.
One of our corporate partners is a tier-one automotive supplier that has asked us to look at viral detection in air as well as on surfaces. That’s a big area that we’re going to look at too. I think that applies to not only automotive but airlines, hospitals, everyone. We have a company called Koniku, whose technology can detect certain illnesses on people just through scent. I don’t think the coronavirus has a scent necessarily, but air detection technologies might be useful.
...but They’re Also Struggling to Distinguish Fads From Long-Term Winners
DiMonte: It’s very hard to trust the numbers at this point. For a company that’s doing really well right now, you might wonder, are they doing really well because they’re so on-trend? Will it continue to do well after coronavirus? It’s hard to know how much of the success is due to tail winds. Conversely, if a company has stopped booking new business, is that because there’s a problem with the company or because the environment is so tight? It’s hard to draw conclusions from the data that was produced over the last two months. And then certainly, with forecasts — no one really knows. I think there’s general consensus that people hitting 50 to 75 percent of plan is good for this year, but it’s still early.
They’re Giving Out Some Bridge Funding, but It’s Not a Sure Thing
Wilcox: You can always go to a venture capitalist and ask for money, but there’s really no guarantee. Statistically, only half of seed-stage companies ever raise the Series A round. For VCs, if the company has been failing, then you probably don’t want to put more money in. No VC wants to put in good money after bad. But at Pillar, if we think there’s just a short term blip where it’s hard for a portfolio company to get cash, then we’re very interested in giving them extra cash. Under these conditions, there’s a chance to really win big. Great companies have a chance to do even better, because there’ll be less noise and less competition.
DiMonte: We have done some internal financing for portfolio companies since coronavirus. It’s actually an easier decision then than it’s made out to be, because CEOs are smart people and they’re optimizing for a few outcomes. Only the folks who really need to ask for it right now are going to go out and do it. As investors, we’re trying to be supportive of our companies, given this is just such a Black Swan event in many ways. If a company was making all the right decisions and got caught in bad timing, you don’t want to punish people for executing well and having bad luck.
They’re Keeping an Eye on Key Market Signals, Like the Length of the Sales Cycle
Wilcox: When should companies start to prepare for growth? For that, I would look at the sales cycle. Let’s say you’re selling enterprise software — how long does that take? Usually it might take you three months to persuade a company to buy; in these uncertain times, it might take six months. Another thing to look at is cost of customer acquisition. How much advertising do you have to do to find a customer? Right now, it doesn’t matter how much you advertise your travel package; no one’s going to buy it. But it’s very industry-specific. If you have a consumer product, like Netflix, right now may be a terrific time to sell.
DiMonte: We’ve been thinking a lot about early demand signals. One is the public market. We’re going through earnings season right now, so you can see how different industries have been affected by the current environment. And then we also spend a lot of time talking about how our different companies are seeing their bookings, or their new sales, change, and trying to correlate those across different industries, or customer segment type, so that we can share collective learnings across our portfolio.
Widdoes: Our corporate partners are our market signal, but I also keep an eye on government regulations. A lot of regulatory items are being relaxed, which is really helping that speed to market. There’s a lot of big shifts happening around telehealth, for example. A lot of our telehealth companies are seeing dramatic upticks in usage by medical professionals, for obvious reasons. Drone technology is another highly regulated, highly restricted area. I think drone technology is really going to take off.
They Foresee a Shift in the Startup Labor Market...
DiMonte: I think that we’re going to see a pretty dramatic shift in the talent market for startups. Our portfolio companies that are still actively hiring have been able to access folks that I think they wouldn’t have had a chance to hire before. And I’m not sure if this is for better or worse, but I think you’ll see some more skills-finishing being contract-based or contract-to-hire based. Over the last couple of years, it was such a tight labor market that if I’m a star salesperson, I probably have a bunch of different companies and roles that I can choose from. So if there was a company that offered me a contract-to-hire role, where I convert to an employee if I do well, I would have never considered that. But you might see more of those situations arise as the power shifts slightly more towards the employers.
… and a Wave of Workplace Automation
Wilcox: Looking forward, I definitely see a lot of automation of work. Right now, if the meat processing plants could find a way to use robotic arms, and every other workstation could be staffed by a robot, so you could have spacing of the human workers — if they were to install that this year, they’re not going to uninstall it. The changes toward automation I think will be accelerated and permanent. And then on delivery, too, if people can figure out a way to deliver things by drone, then once that system is in place, of course it doesn’t go away.
Responses have been condensed and edited.
