Duet Partners
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VCs boost funds but slow startup investments

23rd July 2020

Understanding 1H20 investment patterns will help founders unlock VC war chests

Entrepreneurs have enjoyed one of the most relentless bull markets over the past decade. Putting aside a few momentary setbacks, venture capital deployed into startups has surged.

Over $1.5 trillion was invested between 2010 and 2019, with most of that coming in just the past few years. On this tide of capital, the global startup ecosystem has flourished.

Then Covid hit.

Nothing would seem the same ever again. But whilst startups have been in turmoil over recent months as funding has slowed, public markets have been booming. Investors in turn have been piling into VC funds in anticipation of the recovery.

How do founders now unlock these war chests?

1H20 – the real data is now in

As reported by Dealroom last week, in the first half of 2020 European VCs not only continued to raise significant funds, they raised more than ever before at €9.2B. This means there’s a record amount of dry powder ready to be deployed into European startups during the rest of 2020 and beyond - especially with established fund managers.

This is not just a European phenomenon. In the US, according to Pitchbook, VCs closed $42.7 billion worth of venture vehicles in the first half of 2020, by itself a higher sum than all but three of the past 15 full years. This is important as US investors have been increasingly active participants in overseas markets.

Yet at the same time, investment into companies is declining as the true impact of Covid takes its grip. Crunchbase reports that $17B was invested into venture backed firms across Europe in 1H20, down from $21B in 1H19.

Looking at the quarterly trend across Europe, the decline is even more stark with 2Q20 down 29% on the same period a year ago.

For many UK startups, 2Q20 was bruising

Whilst investments in the UK remains more than double than that of either Germany or France, the picture still looks very uncertain here.

Beauhurst’s latest analysis shows that whilst overall equity raised by UK companies dropped by 30% in 1H20 (v. 1H19) it collapsed by almost 47% in 2Q20 (v. 2Q19). This was heavily driven by a decline in average deal sizes as the number of deals was only down 17% year on year.

Source: Beauhurst

For those seeking their initial round of startup capital it was a really tough period as lockdown impacted deal making. First-time fundraisings took a nosedive, down 15% from 2H19.

For those that had previously raised rounds, many were cap in hand to existing investors for top ups to extend runways, especially at Seed stage. Often this was following some degree of pivoting from the original business model. Here the number of rounds actually increased, up 7% from 2H19.

In Venture and Growth stage businesses, the number of deals declined and reflected a continuing shift to higher average deal sizes that we were witnessing well before Covid. Investors moved to shore up their biggest bets and 1H20 was the best on record for megadeals (investments over £50M) with 22 closing in the period (compared to 17 in 1H19). Overall, deals over £5M soaked up 86% of all invested capital.

But term sheets often contained bad news. 1H20 saw the highest proportion of down rounds on record. 15% of announced deals were completed at a lower valuation than the recipient’s previous funding round.

For those businesses where current investors were already running low on dry powder, the route ahead has sometimes been torturous to navigate. The Government’s Future Fund has provided relief to many. Originally pegged at £250M when launched at the end of May, the fund has now issued £469M of convertible loans to 465 companies from 781 applications over the past 2 months. This has truly been a lifeline for many startups.

A temporary decline or the new normal?

For some businesses, they have simply been in the right place at the right time. Whether through luck or planning, those in certain segments of biotech, e-commerce, remote healthcare, remote working, and privacy & security, have been accelerated by Covid. Meanwhile, big swathes of transportation, retail, and hospitality, have suffered badly.

For many that were seeking external investment in 1H20, their pre-Covid investment propositions were heavily impacted right in the middle of capital raising. We have spoken to many founders that simply gave up after calling fruitlessly on dozens of investors.

Fort those between funding rounds, the focus has been on raising bridge finance to extend the cash runway, keeping the company alive until markets improve. However, in so many cases, what should have been a quick internal round has proven to be a very arduous process. Often this has been due to poor alignment in stakeholder vision, clouded by post-Covid anxiety. None of this has been helped by having to conduct all investor meetings via Zoom. Founders are frazzled.

Of course, the question that all investors are firing at companies is almost impossible to answer right now: Is the fall in demand a temporary decline that will bounce back soon or is this the new normal? This is a very tough call for founders to make with any certainty, especially when already overloaded with increasing operational challenges.

Yet it seems certain now that the scale of the impact made by Covid on startups is beyond what anyone contemplated when lockdown began. Almost the entire global economy has been put on pause, and some aspects may never return.

Reworking the growth story

Founders are now having to navigate without the map they had so carefully developed pre-Covid. Many have not been trained to deal with or had the experience of living through an existential crisis.

Sound business principles and instincts are incredibly important, but rarely enough in a startup environment where business creation methods developed in large companies will often do more harm than good.

Founders must once again search for then execute the new business model that will propel them forward. Lean startup methods are crucial for their speed and efficiency. Investors – those with those mounds of dry powder – will be eager to see the evidence that confirms companies are once more on the growth pathway and hitting the key milestones.

Many of the founders we have worked with during the last quarter have seen just how challenging the new funding environment is at first hand and have come to us for answers. As a result, our own resources have been heavily focused on providing the tools and methods for urgent business model redevelopment, creating revitalised investment propositions, and identifying new and often more appropriate sources of capital.

Our immediate aim overall has been to enable founders to quickly make more informed decisions about a new funding strategy that will see them through Covid to the next major milestone.

What happens next?

It’s almost impossible to find an analyst who will ‘call’ Q3, let alone the second half of the year. But there are some things we can be fairly sure of for the next few months:

As long as uncertainty prevails and the prospect of continued economic decline persists, investors will act cautiously. If exit events (e.g. IPOs) are further curtailed, investors in funds (Limited Partners) may start to rethink longer term plans to manage their own liquidity. This may impact the scale of new VC funds later in the year.

VCs need to find a home for their money and the pressure to deploy capital will gradually build, especially for those that already have new funds. With current portfolios now under control they will seek new opportunities with increasing urgency.

The founder side of this is that we are firmly in an era of evidence-based investing. “Show me the evidence you are on track for growth and I’ll show you the money.” Founders need a plan to deliver this that aligns with the revised funding strategy.

Valuations will remain under pressure. The private investor community knows this is a time for bargains and in a majority of cases this is very much a buyer’s market. The more ‘evidence’ you have the stronger your negotiating position will be.

Finally, virtual methods for deal sourcing, qualification (meeting with founders and teams) and closing will continue. No-one likes this process as it removes the more nuanced elements of the face to face meeting, but we have to get used to it. Founders that are able to adapt and convey a compelling Zoom story will have the edge.

About the author: John Hall is CEO and co-founder of Duet Partners, a corporate finance firm that provides specialist funding support to high growth technology businesses. His 30-year tech career began with major US semiconductor and software companies, and was based in the Valley during the late '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 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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