Duet Partners
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Raising capital amid the Covid-19 crisis

8th April 2020

A reality check for early stage businesses currently seeking VC investment

This is a deeply worrying time for founders of early stage businesses. In the face of Covid-19 the funding market is going through a hard reset. As a result, companies looking to undertake financing rounds in the coming months are under intense pressure. Some great new businesses will fail if they can’t find a path to capital soon.

To make matters worse, founders trying to navigate this maze are having to decipher conflicting messages. Incumbent investors are telling them to dramatically reduce their expectations of pulling in new investors for the foreseeable future. The message is that VCs are going to be preoccupied with their own portfolios for a while.

Yet, at the same time, some of these very same VCs are actively promoting their funds to new companies, claiming they are ‘open for business’. Open-source lists with hundreds of ‘active’ VCs are being published online. Some of these investors, particularly those that have launched major new funds in recent months, are out there with genuine intent. But there are many that aren’t and only have false hope to offer.

This is all very confusing for founders.

A certain amount of hedging by investors is to be expected. Until VCs can get a strong fix on the needs of their current portfolios and some sighting of a Corona exit plan, most will simply step back from the table. However, good deal flow is the lifeblood of any fund manager, so they have to be seen to be ‘in the market’ even if they are still just taking stock.

The reality is that for the hundreds of VCs claiming to be ‘open for business’, there are probably less than 20 tech VCs across Europe that are truly still in the game – at least for now. These are mostly top tier funds that have enormous fire power and can ride out almost any storm. More than that they have the dry powder to see a big downturn as an opportunity.

Sooner or later though the brakes will get eased off. Investor confidence will gradually return, and capital will slowly start to flow again. We are already seeing this happen in China. According to Pitchbook, Chinese firms recorded 66 venture capital deals for the week ended March 28, the most of any week in 2020 and just below figures from the same time last year.

Many investors share a belief that companies formed during recessions end up being some of the most successful. The global financial crisis of 2008/9 gave birth to some of the most highly valued VC-backed businesses in recent times, such as WhatsApp, Slack, GitHub, Airbnb, Stripe, Uber, Waymo and Pinterest. All these businesses had something special. Something that was ‘of their time’. Whilst the rest of the world was falling down around them, they were starting out against the odds.

Investors won’t want to miss this next wave. Globally, venture capitalists had around $188.7 billion in dry powder as of mid-year 2019, according to Pitchbook, and this will eventually need to be deployed.

In the meantime, many founders are busily reworking their plans. Companies will need to be ready as the competition for capital will be sky high. We’re working closely with a group of truly worthy businesses that are using this time to actively prepare. Whilst initiatives vary depending on sector and stage, these are some of core steps that we are facilitating:

1. Stress test your business model with brutal honesty

Go back to basics and re-examine your core business model assumptions, placing major emphasis on current customer feedback. Figure out what has changed in your market. In particular, is the underlying Problem/Solution hypothesis still intact? Be certain that the earth hasn't moved beneath your feet in the past few weeks. For some companies the shift has been seismic.

The downside: The key question here is around timing. Your proposition may still ultimately be compelling, but if the timescales for market adoption have moved out by 12 months or more, your Problem/Solution hypothesis could be in trouble. The defensive posture is to hunker down or hibernate if you truly believe your long-term thesis remains intact, but this could be a very hard call to make. The offensive posture is to pivot, leveraging factors that are more under your immediate control.

The upside: This will depend on your sector, but you could find yourself in the right place at the right time. Suddenly your investment proposition may be centre stage. According to Pitchbook, examples of verticals that are currently surging include certain applications within: Retail health & Wellness tech, Foodtech, IoT, Artificial intelligence & machine learning, Insurtech, Fintech, Supply chain tech, Cloudtech, and Infosec. If you’re in a sector that is being accelerated by Covid-19 then investors will want to talk.

2. Rapidly invent and implement new leading indicators

It may just be too early to see through the fog of the current disruption. Lagging indicators (revenue, customer satisfaction, returns…) are still vital but you may need to revamp your early warning system so you can adjust your activities with greater speed.

Leading indicators, especially around the early stages of customer engagement and revenue pipeline development, have become more critical than ever. We need more data points to inform our decisions and ultimately share with investors. Again, place major emphasis on tracking customer behaviour and rethink what KPIs will provide the greatest and earliest insight. Don’t be frightened about inventing your own.

Update a ‘KPI dashboard’ daily and monitor closely for new trends. First-hand customer data is now of premium value. Share and debate ruthlessly with your team.

3. Financial scenario planning

The financial model you developed as you started your funding preparation will now come into its own. It’s critical that you have the ability to quickly and easily flex the model as new data arrives.

The underlying assumptions will be tested like never before as they shift around over the coming weeks. Until the picture is a lot clearer, assessing multiple scenarios (for revenue and cost variations) is vital so you can quickly see the cash impact and the implications for the funding timetable.

Again, share and debate ruthlessly with your team. This also makes those that may feel very uncertain about the future an active part of the solution.

A solid financial model is one of the most powerful tools you have in your armoury right now - use it with conviction and rally the creative minds around you.

4. Rework the investment narrative

Investors will expect the highest degree of transparency in the face of these unique market circumstances. Your assessment of Covid-19 risks and opportunities will be essential.

When you have a clear grip on how your fortunes have likely changed, you will need to rethink your messaging. The pitch deck will need to be reworked – you may even need to start again if there has been a fundamental Problem/Solution shift.

You’ll then need to prepare for more expansive due diligence and expect the rest of the process to take longer. You must feel confident that during this time your assumptions will hold up.

Eventually, if you've done a great job, you'll start receiving offers. If we're still in the grip of Corona uncertainty, expect high 'risk premium' terms from investors. This is a whole topic in its own right, so more on this in a subsequent post.

In summary:

  • Be very circumspect about what investors are saying publicly. ‘Open for business’ doesn't necessarily mean what you think it does.
  • Companies formed during recessions end up being some of the most successful. Investors will want to catch the next wave. Record amounts of dry powder are sitting on the sidelines.
  • When the brakes are eased off, be ready. Use the intervening time to rework plans based on the latest customer feedback. If your Problem/Solution hypothesis is not still intact, take immediate action.
  • If you remain confident, monitor as many leading indicators as you can, develop financial scenarios and key decision points. Debate everything with the team. Be open.
  • Finally, when you truly believe you are ready, rework investor materials. Your assessment of Covid-19 risks and opportunities will be an essential addition.

This article was also published on Medium

About the author: John Hall is CEO and co-founder of Duet Partners. His 30-year tech career began with major US semiconductor and software companies, and was based in Silicon Valley during the '90's. Before Duet he was CEO of a VC-backed consumer electronics company, sold in 2009 following several rounds of capital raising. In the past 10 years since starting Duet he has advised dozens of founders on the startup to scaleup journey and is a retained Board advisor to a number of UK technology companies.

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