Investors Need to See Your A, B, & C Scenarios in a Post COVID-19 World
As part of the German Accelerator “Pass the Mic” series, we recently hosted a virtual fireside chat to update startups on how COVID-19 is impacting the 2020 investment landscape and highlighted what these changes could mean for young German companies seeking to raise money in the U.S. Angel Investor and German Accelerator Program CEO Christian Busch and #GAmentors Charlie Cameron (HUB Angels) and Morgan Lai (Foundation Capital) shared their insights on the current investment dynamics. The speakers were able to provide not only a broad industry perspective, but a transatlantic perspective as well.
The 2020 investment scene has witnessed its fair share of changes over the past few weeks; however, the overall impact will vary depending on industry and stage of companies. The panel indicated that investors are focusing internally on their existing portfolios and working with entrepreneurs they know and with whom they are comfortable. The panelists also suggested that startups explore alternative options to VC investments, and get creative about how to manage costs and bring new talent into their workforces.
Can you frame the impact COVID-19 has had on the investment community in general?
Charlie Cameron: We are early in the cycle, but everyone is trying to work through the process. The bottom line is that every VC I have spoken to is still in business and still investing. With that said, we have seen data indicating there was a really big drop in the investment in early-stage companies in March through early April. The overall impact however, will differ depending on the industry and stage of the companies. Startups that are not based in the U.S. in particular will have a harder time raising money since VC funds will not invest in a foreign entity, as it is an extra risk factor in this environment. Especially on the tech side, investors are asking if a company’s strategy is to bring its business online. VCs are looking internally at their existing portfolios – mentoring their portfolio companies and helping them with their cost structure
Morgan Lai: We don’t know when the drop will happen in a potential market downturn. Currently, we are seeing a very significant investing slowdown on the growth-stage investment side. For funds that are still in the middle of fundraising, I have seen those funds pause their investing 100%. From a startup perspective, the top performing startups will still have the same valuation, but the mid-tier startups will see an impact. From my perspective, the bar for the companies we are looking to invest in is much higher. Founders need to address how their go-to-market strategy and revenue projections will change in regards to the COVID-19 situation. If you can demonstrate your plan for recession proofing, investors will be much more comfortable.
Christian Busch: The funds I am an investor in are very active and have a lot of capital to deploy. We are focusing on healthcare, platform businesses, and industries that may even benefit from the current environment, such as insurance for freelancers. In the startup space you can also see the wheat separating from the chaff. Good companies are getting capital, and if anything, it is probably more concentrated than in the past – fewer companies getting larger investments. The capital markets in Germany and Asia are still active and seeing the same trends that the U.S. is seeing. In general, if you are doing really well you will have even more access to capital.
What are some available alternatives to VC investments?
Charlie Cameron: There are several options: grants, family offices, individual Angels, Angel groups, strategic investors, governments, etc. Having a CEO that has been funded before and has contacts is super important in this environment, because it is hard for VCs to get to know a person based just on Zoom. Recently, venture investors have been much more selective and have been biased towards the big companies. If you are in an area that is favored right now, people are still investing. A lesson is that you really need to do your homework in terms of where the capital is, what investors are looking for, and what connections you need to get to them.
Morgan Lai: To clarify an earlier point, if you are raising pre-seed or seed, the valuations haven’t come down yet. If you are raising Series A-C, I am seeing a slight valuation adjustment. I would encourage companies to think about different use cases. For instance, I have come across a software solution that has rebranded and changed their website to become more relevant to the current COVID-19 situation.
Christian Busch: I disagree with Morgan’s observation on the early-stage side, as I am witnessing the valuations really coming down. Although, it does depend on the quality of the teams and how easy they have access to capital. I think if your product is flexible, you can certainly reposition to VCs, but you need to be careful that what you are doing is a legitimate evolution of your business model and not a forced pivot. Most investors are asking why invest in companies who pivot right now, if you can invest in top quality companies?
Do you see angel investors holding back on early-stage investment and therefore see VCs filling the gap?
Charlie Cameron: The Angel community is not one homogenous group – there are Angel funds, Angel groups, and individual investors. For the Angel groups that do not have a fund, it is hit or miss because when people get hit in the public market, they pull back in general. Individual Angels are a mix, as some are very well heeled and invest during the ups and downs. In summary, it really depends on what kind of Angels you are contacting.
Christian Busch: To me, the lines between some Angel groups and some VCs are blurring. I have a list of 150 micro-VC funds in the New York City area between $5-50M. When you are building your cap table, you don’t want to have a “party round” of smaller investors, meaning that you have 10-20 individuals who each throw in money but no one is taking a leadership role. I would recommend finding a fund with an experienced general partner who would support you.
Morgan Lai: It is important to have an institutional investor with close to 10% of ownership of the company, so they are incentivized to bridge the round.
Particularly for MedTech, can you quantify the impact on early-stage valuations post COVID-19?
Charlie Cameron: While MedTech is big in Germany, it is not favored by many VCs in the U.S. right now. There are lots of issues getting a medical device through the FDA, getting it accepted by practitioners, scaling up, etc. A handful of big device makers are the usual exit. They see an enormous number of devices but buy very few. You need to keep in mind that VCs are making decisions based on the totality of their deal flow. It is never your individual company, it is your company versus everything else on their plate. They are in the risk management business and need to make balanced judgements. Many times medical device companies do not make the cut. If you go back and look at the down-turn cycles over the course of the past 20 years, depending on the length and depth of the cycles, you find that as the cycles go on, people get more frustrated. Investors in new rounds dictate the rules and can wash-out previous investors, revalue a company, change leadership, reprice options, and recalibrate the future of a company. Limited Partners (LPs) might start to hold back, fewer new funds are created, and fewer venture funds are deploying new capital. You need to carefully identify those funds that are still in medtech and create a strategy to get to them. Of course, we have to be careful here to make big projections as we are early in this cycle. In summary, for years, medical device companies have not been a high priority for VCs in the U.S. I believe we will see a drop in valuation for those companies, but that is just a guess.
What suggestions do you have for early-revenue companies thinking about furloughing employees to extend their cash?
Christian Busch: In general, if you have to cut, I always look at cutting pretty deep right away. In terms of runway, I would think if you are only funded through the end of the year, you are in trouble. Before there is a COVID-19 vaccine available, I don’t believe the economy is going to go back to normal. I would recommend extending your runway to next summer.
Charlie Cameron: It’s not just a one-size fits all solution, there are different options you have. On the upside of all this, there are a lot of people in the market right now who need jobs. Some of the bigger companies are able to buy talent. If possible, you should restructure your costs based upon lower salaries and lower bonuses. You can look at it as an opportunity to get in cheaper labor. I’m finding a lot of partners in VC funds helping their companies to find/ replace talent and pulling together a financing or a bridge. What I am hearing is that if it is a priced round, valuations will come down. One large west coast VC told me that they are recommending that their portfolio companies plan for a 3-year runway, which, in some cases, has led to big layoffs. All VCs have told me that they want to see scenarios A, B, and C since we don’t know where this is going.
Final thoughts, words of advice for startups during this time?
Christian Busch: A lot of great companies get creative during recessions and right now a lot of funds are creating spectacular returns. It is actually a great time to start a company in the right space since barriers to entry are lower and there is great talent out there. So go for it, don’t sit in the corporate office for another three years and wait for something to happen. The time is now! Since we are headed into a recession, solutions that help companies or individuals save money will be winners. Property tech, real estate tech, hospitality, or anything capital heavy are areas I would avoid investing in right now.
Charlie Cameron: This is a changed environment, and you need to think about what will be funded in the next 9 months through the next 2 years. If possible, align with a CEO or COO who have done this before because that seems to be an anchor for a lot of VCs. If they have worked with someone before and had success, those are the people they are likely to be funded in the future. Also, I am hearing that strategies that are AI and tech-enabled will more likely be winners when it comes to finding capital. That said, we are early in the cycle and the funding environment can change very quickly.
Morgan Lai: Be bold at difficult times and take calculated risks. Simultaneously, try to buy time so you will be able to mitigate unknown situations.