This short briefing note is prepared for founders who are considering, or are in the process of raising seed capital. The last few weeks have seen a significant shift in terms of the fundraising atmosphere, and investors’ appetite for risk.
In my position at an accelerator program in London, one of the world’s financial hubs, we have access to a wide range of sources across the early stage investing spectrum; seed funds, later stage investors, angels.
Much of the content below is being surfaced from conversations that our team have had with these nodes in our network as we strive to make sense of the market, and what founders can do to survive and thrive in this new environment.
Please be aware that most of our relationships and active conversations in the past few days are from European based investors, some of this may apply in the US, but we have not been able to verify that very clearly.
The first thing that will happen in any crisis is that businesses will stop and think. This is true in the corporate sector, where marketing budgets, new partnerships and many contracts are being paused, and it is the same with early stage investors. This process will probably take several weeks, after which we may see a resumption, or an extended chill depending on whatever relevant macro factors prevail.
Overall, conditions are likely to be more challenging for a period of at least six months, and you should expect pressure on fundraising time, valuations and securing (and keeping) firm commitments.
Lots of VC firms have put a halt on deploying funds temporarily, you may not notice this immediately, since deal completion PR announcements are a trailing indicator of activity and only happen at the end of a long process. In addition, for form's sake, many firms are saying they are continuing, but this is tending to be focused around re-evaluating their existing pipeline rather than actively adding much to the top of the funnel.
A number of VCs are reporting they are conserving their existing funds to ensure their current portfolio has access to follow on investment, since there is likely to be fuel needed to keep existing bets moving forward through the crisis. Sad to say, it seems that some existing term sheets are being renegotiated and/or revalued, while we also hear that many are being honoured.
In terms of valuation, seed stage valuations may experience some price pressure, but will be limited since quite often investors here are buying the team, and the potential at an already (relatively) low valuation. Those raising later stage funds will be more affected - there is some talk of up to 50% reduction in valuations at series A and later. However, be prepared to be flexible, this is not the time to optimise for valuation at a higher level allowing the time to tick by. Things will get harder before they get easier.
In a recent survey in a private WhatsApp group, around 50% of respondents said that their firm is concerned about LPs fulfilling future capital calls. Most people only think about the startup investment part of the VC business model, but in reality the venture fund acts as an intermediary between large institutional investors (family offices, pension funds, UHNWIs), collectively the “limited partners” (LPs) in a fund, who wish to put money into early stage businesses, and startups in need of financing. Right now LPs need to restructure their portfolio of assets to reduce risk, meaning less cash is being allocated to VC and PE. More detail on this trend here.
This all sounds pretty scary, and as a founder I can imagine you feeling a sense of creeping dread when you look at your monthly burn down. The reality is investors are looking to deploy some money, it’s just that the game has gotten a lot more competitive.
Remember the story of the two hikers walking in the woods, they see a bear stalking them in the undergrowth looking for it’s next meal, and one of the hikers kneels down to change his boots into running shoes. The second hiker says “why are you doing that, you would never outrun a bear”. The first one replies “I don’t have to outrun the bear, I just need to outrun you”.
When considering how to be as attractive to investors as possible in this competitive market environment, consider these areas:
1. Demonstrate your route to sustainability
The last few years have been a sellers market for venture equity and other more exotic instruments. It may not feel like it but it was. Your investor story needs now to demonstrate that you have a path to revenue / cash generation. Considering Europe specifically, the current sentiment seems to be shifting from revenue at seed = higher valuation, towards revenue at seed = closing a round successfully (at least over the next few months)
It’s worth bearing in mind that we’re hearing from enterprise / corporate contacts that any new partnerships or customer contracts may be delayed. We are hearing from founders reports from market of 20-50% extension in anticipated enterprise contract closing time.
2. Get enough runway
Aim to build in an 18+ month runway from your round, ideally building towards profitability during this time. This will enable you to get over the worst of any fall out, as well as build confidence from your investors that you will not run out of fuel before the crisis is over. Be prepared to accept more dilution to achieve this.
3. Demonstrate an understanding that you can control costs
Develop responsible plans that show you are able to create tight cost control focused around delivering value in your product roadmap in an efficient way. For example some very lean companies are keeping talent by reducing commitment from 5 days to 4 days a week. This is 20% saved on salaries. You could also try to kickback some options or renegotiate vesting in lieu of lower cash compensation. However you do it, it’s easier to save 10% for 10 months than 50% for two months, so think ahead.
Potentially close your round now if you are in a position to do so,
Related to the first point, VCs are likely going to be stalling until things settle down, even if they have money, as much as possible try to apply pressure when closing
Speak to your existing committed investors and consider rolling on the ability for people to contribute at the same valuation. Be flexible
Look into less conventional financing like grants (Innovate UK and Horizon 2020 in the UK). Take advantage of the COVID programs that are being released (eg small business loans)
Lower your valuation expectations and take whatever reasonable deal you can get
Start now. Focus on your existing investors, and anyone who can decide quickly
Be more flexible on valuations, you need to bank absolutely minimum 6-9 months runway
In terms of pitch, emphasise the quality of the team and demonstrate the viability of the commercials in your business
Get customers - (ideally paying) and investors will follow. If you focus energies on winning customers then the funding round will be easier, shorter, and at a higher valuation.
Review your spending plan for the next few months and review it monthly from now on. Have contingency plans in place to reduce further if necessary. This COVID-19 matrix briefing note from Sequoia is useful
Aim to immediately build in 20-30% more runway by cost reductions
Deliver on the plan, but bear in mind you will need to demonstrate commercial traction at the end of your runway. This should be your number 1 priority
Hit the phones and get some real users and paying customers, the market will be less forgiving in 6-12 months and will want to see solid traction.
There is still money around, interest rates are so low and funds need to deploy to earn their management fee. Your job in investor relations is to be the most attractive deal available right now. The keywords at seed (as ever) are team, business model, traction, sales, flexibility.
Stay safe out there.