Public markets have taken a beating since the outbreak of the novel coronavirus, turning what many considered a strong global economy into one on the brink of recession.
Now, a similar effect is playing out in the private markets.
Startups, already considered extremely risky businesses with very little cash flow, say they must adapt to account for lower revenue projections, and potentially even change their business models.
Meanwhile, investors say capital will likely dry up in the short term, as they focus on their current portfolios and reassess how they value companies and what they look for in new investments.
Global private market funding in the first quarter of 2020 is on pace to reach $77 billion, down more than 16 percent compared to the fourth quarter of 2019 and down nearly 12 percent versus the first quarter of 2019, according to CBInsights.
“When capital is accessible and cheap, it’s easy to forget that ‘cash is king’ and positive unit economics matter,” Mathew Farkash, a founding organizer of the Brown Angel Group, told Rhode Island Inno. “When the music stops and the capital retreats, companies that have been buying growth and burning cash will either need to re-trench or shutdown. Even the companies with strong balance sheets will be negatively impacted by the current environment.”
Valuations Will Reset and Capital Will Slow
If one thing is clear, there will be a new reality when it comes to valuations.
As Farkash sees it, with private company valuations being largely driven by supply-and-demand dynamics, even typically resilient businesses will need to approach valuations with more realistic expectations. Before the pandemic, it was abundantly evident that private company valuations were overpriced. Now, the virus will accelerate this correction, and startups can expect valuations to “similarly have a hard reset,” he said.
There will also likely be less capital available.
A new term he likes to use now when evaluating potential investments: “COVID-proof.”
“It’s not a great time to be reaching out to investors, because investors will be inherently concerned with their current portfolio,” said Adam Alpert, co-founder of Pangea, an app that helps companies connect with college students for freelance work or contract projects.
Daniel Rossignol, a Rhode Island-based startup advisor and investor and current vice president of operations at Boston-based life sciences startup Clora, agreed that raising funding is going to be difficult in the current climate.
“Investors need to double down on their existing funds in their portfolio,” he said. “There is a good chance that 30 to 40 percent of their portfolios won’t be around in the next 18 months. Investors have to take a really clear and high-conviction look at the investments they’ve made and determine which ones they can bridge.”
Still, for investors, things aren't all bad.
With capital becoming even more scarce than before, venture capitalists will likely be able to invest at lower valuations and have more choice about who they fund. Rossignol expects investors will focus more on companies closer to profitability.
A new term he likes to use now when evaluating potential investments: “COVID-proof.”
“A big question investors will focus on now is, 'Are you able to sustain a marketplace when things get shut down?'” Rossignol said.
It's a Good Time For Startups To Refocus
The current landscape with coronavirus is going to put startups to the test.
Alpert said it is going to be hard for founders that now have to take care of their families all the time to focus on their business. He also said many will need to pivot their business models if they are upended by social distancing, or if a company is in a specific industry hit hard by the virus such as travel.
“A lot of companies don't have more than a 12-month runway, generally, because they raised money and they hired a bunch of people and they are growing and they are expecting revenue,” he said. “Revenue projections are getting cut because of the pending recession, and employees are getting cut as well.”
However, the outlook for his own startup is still promising. Pangea facilitates plenty of remote work—the standard for office employees these days—which means the company is doing well. Alpert said some investors have even reached out to him in the past week, given that Pangea’s model only requires limited human interaction.
Another startup that appears poised to weather the storm: food delivery startup Feast & Fettle, according to Rossignol, who served as an advisor to the company. No one wants to go out into the public to buy food, Rossignol pointed out; plus, startups that help set up business infrastructure for remote employees will be particularly attractive right now.
Rossignol also said this is a clear opportunity for startups need to look long and hard at their business models. That includes his own company, Clora, which has so far raised just over $6 million from Spark Capital and others.
“We are thinking about what we can do to shave any fat in the business, while still providing optimal customer experience,” he said. “We are looking up and down the operating model to see what we need to keep and what we actually might need to spend more money on. We are living in a world now where the customers are going to have more control, and when that shift happens, investors get better deals, which behooves entrepreneurs to maintain strong relationships with them.”
Relief Is Coming for Small Businesses
While the current operating environment will undoubtedly be a challenge for startups over the next 12 to 18 months, there are programs offering small businesses a glimmer of hope.
The U.S. Small Business Administration will soon provide low-interest loans of up to $2 million for local small businesses. Here in Rhode Island, even organizations that provide startup resources—if not direct capital—such as Venture Café Providence have taken their programming virtual so they can still assist startups through office hours, lectures and more.
The challenging environment also presents a good opportunity for startups to prove to the investor community that they can survive in even the worst of economic conditions, said Farkash of the Brown Angel Group.
“There is room for optimism,” Farkash said. “For those that are able to weather the storm—in the post-COVID-19 reality and when the uncertainty recedes—VCs will still have plenty of money to put to work, and at least in the near term, will be operating off the same fundamental business model that requires big swings.”
